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Suppose that we have asset A, B, and C that will deliver cash flows one year later. The cash flows will depend on the state
Suppose that we have asset A, B, and C that will deliver cash flows one year later. The cash flows will depend on the state of economy as follows: (a) Suppose that we want to replicate the cash flows of asset C using asset A and asset B. In other words, we want to construct a portfolio consisting of asset A and asset B such that the portfolio will have the same cash flows as asset C one year later in both boom and recession. How many asset A and asset B do we need in the portfolio? (Hint. Let x denote the number of asset A and y denote the number of asset B. Solve for x and y.) (b) The current price of asset A is $19 and the current price of asset B is $9. If there is no arbitrage, what is the price of asset C
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