What does the one-period binomial model assume about the underlying at expiry?
Show the answer and explanation
Answer: B. It takes one of exactly two possible values
Binomial means two. The model looks at one period only and assumes the underlying price ends in one of exactly two states, an up price or a down price. This simple set-up lets you copy the option's payoff exactly with a mix of the underlying and borrowing or lending. Since two payoffs can be matched with two instruments, the no-arbitrage price is a single number. A normal distribution is a different, continuous-price assumption.
Why the other options are wrong:
A. It follows a normal distribution - That is the continuous-time assumption behind the Black-Scholes framework; the binomial tree uses discrete states.
C. It remains at its current price - Then there would be no uncertainty and nothing to value.