Suppose security C has a payoff of $600 when the economy is weak and $1800 when the economy

is strong. The risk-free interest rate is 4%.

a. Security C has the same payoffs as what portfolio of the securities A and B in problem A.1?

b. What is the no-arbitrage price of security C?

c. What is the expected return of security C if both states are equally likely? What is its risk

premium?

d. What is the difference between the return of security C when the economy is strong and

when it is weak?

e. If security C had a risk premium of 10%, what arbitrage opportunity would be available?