Payoffs without any cost or risk using arbitrage portfolio

Assignment Help Financial Management
Reference no: EM131308249

Suppose there are two states of nature in the future. In the asset market, there are the two contingent claims, one for each state. There’s a third security with payoffs x=(4,2). Suppose the prices of the contingent claims are both 1/2: p(c(s1))= p(c(s2))=1/2. The price of the third security is 4.

a) What is the payoff matrix X of the asset market? Is the market complete or incomplete? Why? Is there any redundant security?

b) What is the price vector p of the securities market?

c) The law of one price says that the securities with the same payoffs must have the same price. Does the LOOP hold here? Why or why not?

d) Find an arbitrage portfolio. Show that one can possibly receive some positive payoffs without any cost or risk using the arbitrage portfolio.

Reference no: EM131308249

Questions Cloud

Financial manager has when managing working capital : What are the goals a financial manager has when managing working capital? What does the manager have under their control to effect the goals? What forces are working against each other in optimizing the goals of the manager?
What is the gross return of the riskfree bond : There are two states of nature (s1, s2) with equal probabilities. Suppose there is a representative agent who is endowed with 1 unit of consumption today, and (2, 1) tomorrow. The agent has power.  What are the risk-neutral probabilities? What is the..
What is the addition to retained earnings : Draiman, Inc., has sales of $585,000, costs of $273,000, depreciation expense of $71,000, interest expense of $38,000, and a tax rate of 35 percent. The firm paid out $36,000 in cash dividends. What is the addition to retained earnings?
Nonquantitative factors best predict bond defaults : Bond rating agencies have invested significant sums money in an effort to determine which quantitative and nonquantitative factors best predict bond defaults. Furthermore, some of the raters invest time and money to meet privately with corporate pers..
Payoffs without any cost or risk using arbitrage portfolio : Suppose there are two states of nature in the future. In the asset market, there are the two contingent claims, one for each state. There’s a third security with payoffs x=(4,2). What is the payoff matrix X of the asset market? Is the market complete..
What bid price per carton should you submit : Guthrie Enterprises needs someone to supply it with 156,000 cartons of machine screws per year to support its manufacturing needs over the next five years, and you’ve decided to bid on the contract. It will cost you $1,960,000 to install the equipmen..
What rate would legally have to be quoted : A local finance company quotes an interest rate of 19.5 percent on one-year loans. So, if you borrow $46,000, the interest for the year will be $8,970. What rate would legally have to be quoted? What is the effective annual rate?
Briefly describe the basic components of the cash budget : Which three statements result as part of the short-term (operating) financial planning process? What is the purpose of the cash budget? What role does the sales forecast play in its preparation? Briefly describe the basic components of the cash budge..
Suspending its dividend payments : A&L Resources just paid a dividend of $1, but is suspending its dividend payments. It plans to start paying a $1 dividend in year 4, and will pay a $1.20 dividend in year 5 when dividends will start growing at 3.5% and r = 10%. What is the price of t..

Reviews

Write a Review

 

Financial Management Questions & Answers

  Major perceptual errors that tend to occur

As Marie and Harry enter into their negotiations, their perceptions of each other will be an important component to the negotiation process. Define perception and the role it plays in the negotiation process. What are the four major perceptual err..

  Expenses are fully deductible and all gains are taxable

Kathy St Andrews is planning to buy a house for $140,000 by borrowing money at the rate of 9%. She expects to rent the house for 6 years, collecting $11,000 annual rent in advance each year. If all the expenses are fully deductible, and all gains are..

  Determine the annual financing cost of the loan

Determine the annual financing cost of the loan under each of the following conditions Kittanning currently maintains $100,000 in its account at the bank that can be used to meet the compensating balance requirement.

  Estimated for an investment opportunity

Jolly Investors Inc. has estimated the following for an investment opportunity: The project is expected to yield cash inflows of $15,000 annually for five years with an initial cash outflow of $50,000. Assume a 10% cost of capital. What is the IRR? A..

  Find the future trends of bio-pharmaceutical companies

Find the future trends of bio-pharmaceutical companies, Gilead Sciences, Inc. , Amgen, Inc. Celgene Corporation, and Roche. What does the financial forecasts look like. Develop a table that shows this forecast.

  What is the break-even level of ebit for plan

Cooke Co. is comparing two different capital structures. Plan I would result in 9,000 shares of stock and $360,000 in debt. Plan II would result in 12,600 shares of stock and $216,000 in debt. The interest rate on the debt is 9 percent. compare both ..

  Cyclical type of business-reflected in dividend policy

ACME is a very cyclical type of business which is reflected in its dividend policy. The firm pays a $2.00 a share dividend every other year. The last dividend was paid last year. Five years from now, the company is repurchasing all of the outstanding..

  Discuss primary financial statements

Discuss primary financial statements published by a corporation, the various classifications used in a balance sheet-What is the purpose of a Balance Sheet? What information does it provide?

  Calculate the weighted average cost of capital-common equity

Given the following information calculate the weighted average cost of capital for Hamilton corp. line up the calculations in the order shown i table 11-1. Debt..35% preferred stock..20 common equity.. 45 additional information bond coupon rate..11% ..

  How many shares must the company sell to the public

A company wants to raise $350 million in a new stock issue. Its investment banker indicates that sale of the new stock will require 20% under pricing an dan 8% spread. if the company’s stock price does not change from its current price of $35 per sha..

  Why he should forgo the home office deduction

He has instructed his accountant to take the most aggressive position possible with respect to these transactions. Mr. JR also wants to take a home office deduction for one of his business activities. The deduction would be only $1,293. Can you sugge..

  Ratios measures operating performance and source of cash

Which of the following is a source of cash? Information that can make a difference to the decision at hand is considered to be. Which of the following increases cash. Which of the following ratios measures operating performance?

Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd