Assignment 8
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assignment8.docx
Assignment 8
1. In each of the following economies there is an arbitrage opportunity. Please explain the source of the arbitrage opportunity and how you would trade to exploit it.
a)
|
|
Asset 1 |
Asset 2 |
|
State 1 |
1 |
3 |
|
State 2 Price |
-0.5 0.5 |
-1.5 2 |
|
b) |
Asset 1 |
Asset 2 |
|
State 1 |
1 |
2 |
|
State 2 |
2 |
6 |
|
Price |
0.5 |
1.5 |
|
c) |
Asset 1 |
Asset 2 |
Asset 3 |
|
|
State 1 1 |
0 |
3 |
|
|
State 2 0 |
1 |
2 |
|
|
Price 0.5 |
1 |
3 |
2. Assume that there are no arbitrage opportunities in the following financial market.
|
|
Asset 1 |
Asset 2 |
|
State 1 |
1 |
3 |
|
State 2 |
0.5 |
1 |
|
Price |
0.4 |
1 |
a) Construct a portfolio of assets 1 and 2 that replicates the payoffs of A-D security 1.
b) Construct a portfolio of assets 1 and 2 that replicates the payoffs of A-D security 2.
c) What are the state prices for states 1 and 2?
d) What is the riskfree rate (interest rate)?
1
