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Consider the three state, two security example that we discussed in class. State Price Recession Normal Boom 90 80 100 0 Security 1 Security 2
Consider the three state, two security example that we discussed in class. State Price Recession Normal Boom 90 80 100 0 Security 1 Security 2 Probability 100 100 100 200 0.2 0.5 0.3 (a) What is the risk-free rate that is implied by the price of security 1? (b) What is the expected return of security 2? (c) Suppose we introduce Security 3, which pays 0 on both the Recession and Normal states and pays 300 in a boom. Is the market complete? (d) For what values of P3 is there no arbitrage? Consider the three state, two security example that we discussed in class. State Price Recession Normal Boom 90 80 100 0 Security 1 Security 2 Probability 100 100 100 200 0.2 0.5 0.3 (a) What is the risk-free rate that is implied by the price of security 1? (b) What is the expected return of security 2? (c) Suppose we introduce Security 3, which pays 0 on both the Recession and Normal states and pays 300 in a boom. Is the market complete? (d) For what values of P3 is there no arbitrage
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