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..

User Account

All Pages