Arbitrage is the condition under which two equivalent assets or derivatives or combination of assets and derivatives sell for different prices.
Replication is the creation of an asset or a portfolio from another asset, portfolio, and/or derivative. Example: stock + short forward = risk-free asset.
Risk neutrality: The risk aversion of an individual does not impact derivative pricing. The risk-free rate is used for pricing derivatives.
The overall process of pricing derivatives by arbitrage and risk neutrality is called arbitrage-free pricing. According to this process,
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