(ECON5106 only) Suppose that instead of Arrow-Debreu securities there are two securities, a (risky) bond and a stock, available for trade in this economy. The bond pays 1 apple in GW and FW, but 0 in BW, while the stock pays 2, 1 and 0 apples in GW, FW and BW, respectively. Each trader is able to commit to their claim.

4. What is the competitive equilibrium now? (1 mark)

5. What is the type of this option (call or put)? What is the range of the strike price of this option? Design such an option and show how it completes the market.(2 marks)

6. Characterise the competitive equilibrium with bond, stock and the security you designed. (1 mark)

7. Explain how financial innovation affects the social desirability of the allocations in the economy. (1 mark)