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I. a) A zero-coupon bond has a face value of $210 and matures in 1 year. The rate of return on equally risky assets is
I. a) A zero-coupon bond has a face value of $210 and matures in 1 year. The rate of return on equally risky assets is 5% (.05). What will its price be today? Suppose that Suppose that the price were below the number you found. Suppose that the price is $195. Describe the arbitrage opportunity that would exist in this case and find the arbitrage profits. What will be the effect of arbitrage on the price? b) A stock is expected to pay an annual dividend of $4 each year into the indefinite future. Rates of return on equally risky assets are 5% (.05). The stock price is $100. Is there a bubble on this stock? How do you know ? How big is the bubble? To be consistent with no arbitrage possibilities, what price are people expecting the stock will have next year? Explain
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