Question

Market Price ($) Cash Flow in One Year ($) Security Today Poor Economy Good Economy A...

Market Price ($)

Cash Flow in One Year ($)

Security

Today

Poor Economy

Good Economy

A

450

800

0

B

300

0

800

C

???

4000

              800

  1. Calculate the no-arbitrage price for security C?
  2. Calculate value of the risk free rate

Homework Answers

Answer #1

1.
Security C can be constructed by buying 5 unit of Security A and 1 unit of Security B

Hence, Price of Security C=Price of 5 units of Security A+Price of 1 unit of Security B=450*5+300*1=2550.00

2.
Let risk free rate be p
Let probability of poor economy be p and probability of good economy be 1-p

From Security A: 800*p/(1+r)=450

From Security B: 800*(1-p)/(1+r)=300

Solving the two simultaneously, we get
p/(1-p)=450/300
=>1/p-1=300/450
=>1/p=300/450+1
=>p=1/(300/450+1)

and r=800/(300/450+1)*1/450-1=6.6667%

Know the answer?
Your Answer:

Post as a guest

Your Name:

What's your source?

Earn Coins

Coins can be redeemed for fabulous gifts.

Not the answer you're looking for?
Ask your own homework help question
Similar Questions
QUESTION 10 Market Price ($) Cash Flow in One Year ($) Security Today Poor Economy Good...
QUESTION 10 Market Price ($) Cash Flow in One Year ($) Security Today Poor Economy Good Economy A 450 800 0 B 300 0 800 C ??? 800 4000 Calculate the no-arbitrage price for security C? Calculate value of the risk free rate.
Question 72. Suppose a risky security pays an average cash flow of $100 in one year....
Question 72. Suppose a risky security pays an average cash flow of $100 in one year. The risk-free rate is 5%, and the expected return on the market index is 13%. If the returns on this security are high when the economy is strong and low when the economy is weak, but the returns vary by only half as much as the market index, then the price for this risky security is closest to: A. 88 B. 92 C. 93...
Suppose a project is dependent on whether there is a good economy and whether a competitor...
Suppose a project is dependent on whether there is a good economy and whether a competitor enters the market. If there is no competitor, the project will produce $50 million in a good economy and $15 million in a poor economy. If there is a competitor, the project will produce $30 million in a good economy and $10 million in a poor economy. The probability of a good economy is 60%, versus 40% for a poor economy; and the probability...
Project Cash Flow Today (millions) Cash Flow in One Year (millions) A -$10 $20 B $6...
Project Cash Flow Today (millions) Cash Flow in One Year (millions) A -$10 $20 B $6 $4 C $18 -$12 Suppose all cash flows are certain and the​ risk-free interest rate is 5%. a. What is the NPV of each​ project? b. If the firm can choose only one of these​ projects, which should it​ choose? c. If the firm can choose any two of these​ projects, which should it​ choose?
Consider a project with free cash flow in one year of $140,738 or $162,796​, with either...
Consider a project with free cash flow in one year of $140,738 or $162,796​, with either outcome being equally likely. The initial investment required for the project is $80,000​, and the​ project's cost of capital is 18%. The​ risk-free interest rate is 11%. ​(Assume no taxes or distress​ costs.) a. What is the NPV of this​ project? b. Suppose that to raise the funds for the initial​ investment, the project is sold to investors as an​ all-equity firm. The equity...
The firm Lando expects cash flows in one year’s time of $90 million if the economy...
The firm Lando expects cash flows in one year’s time of $90 million if the economy is in a good state or $40 million if it is in a bad state. Both states are equally likely. The firm also has debt with face value $65 million due in one year. Lando is considering a new project that would require an investment of $30 million today and would result in a cash flow in one year’s time of $47 million in...
Consider the securities shown here that are trading at their respective market prices. The two securities...
Consider the securities shown here that are trading at their respective market prices. The two securities pay risk-free cash flows over the next two years. Market Prices CF in one year CF in two years Security A $857 900 0 Security B $181 0 200 Suppose that a security C has cash flows of: 450 in one year and 200 in 2 years and it is trading for a price of $611. What arbitrage opportunity is available? Buy 2 C;...
A project has an expected risky cash flow of $300, in year t= 3. The risk-free...
A project has an expected risky cash flow of $300, in year t= 3. The risk-free rate is 5percent, the market risk premium is 8percent and the project's beta is 1.25. Calculate the certainty equivalent cash flow for year t=3.
Suppose the market price of the security from question 2 is $700. Is there an arbitrage...
Suppose the market price of the security from question 2 is $700. Is there an arbitrage opportunity? If “yes”, please specify actions that should be taken to perform the arbitrage (be very specific, indicate all cash flows associated with the arbitrage) and state arbitrage profit. Please provide the solutions to the following questions in the box below. Back up your answers with calculations. [This is question 2 with the answer] Q2: Suppose a security generates the following risk free cash...
Suppose security C is expected to be worth $800 if the economy is weak and $300...
Suppose security C is expected to be worth $800 if the economy is weak and $300 if the economy is strong in one year (with equal probabilities). Currently, the price of the security is $500. Compute possible rates of return for the security over the coming year. Compute expected rate of return of the security Find range for possible values o returns Suppose that on average returns of other risky securities in the market fluctuate in the range of ±...
ADVERTISEMENT
Need Online Homework Help?

Get Answers For Free
Most questions answered within 1 hours.

Ask a Question
ADVERTISEMENT