Suppose a risky security pays an expected cash flow of $79 in one year. The risk-free rate is 4.4%, and the expected return on the market index is 9.6%.

a. If the returns of 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, what risk premium is appropriate for this security?

b. What is the security’s market price?

Arbitrage with Transactions Costs AppendixLO1