Risk averse agents with utility u(c) = 2c and subjective discount factor = 0.98 live in the world that repeats itself period after period. There are two possible states, A and B. State A occurs with probability 0.6 and B 0.4. In state Aconsumption grows at the rate of 5%, in state B -3%.

(a) Compute the prices of one-period state contingent claims (state price vector (qA,qB)).

(b) AtypeAAtwo-periodstate-contingentclaimisasecuritythatpays1unitofgoods two periods from now only if the world was at state A in both periods. There are four types of two-period state-contingent claims. Calculate their prices.

(c) What is the price of a one-period zero coupon bond and a two-period zero coupon bond, both with a face value of 1?

(d) Based on your calculation, what does the term structure of interest look like in this world?