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2. Arbitrage Using a Forward A stock currently sells for $80, and it will pay no dividends in the future. Consider a 2-year forward contract

2. Arbitrage Using a Forward A stock currently sells for $80, and it will pay no dividends in the future. Consider a 2-year forward contract on this stock. The forward price is $90. The risk-free rate is 3% per annum. Is there an arbitrage? If so, show the arbitrage strategy using a table listing asset positions and cash ows.

3. No Arbitrage Argument Suppose that we have asset A, B, and C that will deliver cash ows one year later. The cash ows will depend on the state of economy as follows:

Asset Boom Recession A 25 20 B 10 10 C 20 25

(a) Suppose that we want to replicate the cash ows of asset C using asset A and asset B. In other words, we want to construct a portfolio consisting of asset A and asset B such that the portfolio will have the same cash ows as asset C one year later in both boom and recession. How many asset A and asset B do we need in the portfolio? (Hint. Let x denote the number of asset A and y denote the number of asset B. Solve for x and y.)

(b) The current price of asset A is $19 and the current price of asset B is $9. If there is no arbitrage, what is the price of asset C?

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