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2. There are two securities in one single-period financial market. One is a riskfree security with annual return r. The other one is a risky
2. There are two securities in one single-period financial market. One is a riskfree security with annual return r. The other one is a risky asset with future price St, St follows a binomial distribution as follows: P(ST = u) = p, P(St = d) = 1 - p. Assume that both securities have values $1 at time 0. (a) State the conditions under which the market is free of arbitrage. (b) Assume that the market is arbitrage-free. Consider one security whose payoff is $2 at time 1 if the risky asset price equals u, and $1 at time 1 if the risky asset price equals d. Calculate the no-arbitrage value of this security at time 0. 2. There are two securities in one single-period financial market. One is a riskfree security with annual return r. The other one is a risky asset with future price St, St follows a binomial distribution as follows: P(ST = u) = p, P(St = d) = 1 - p. Assume that both securities have values $1 at time 0. (a) State the conditions under which the market is free of arbitrage. (b) Assume that the market is arbitrage-free. Consider one security whose payoff is $2 at time 1 if the risky asset price equals u, and $1 at time 1 if the risky asset price equals d. Calculate the no-arbitrage value of this security at time 0
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