Question
Suppose the market price of the security from question 2 is $700. Is there an arbitrage opportunity? If yes, please specify actions that should be
Suppose the market price of the security from question 2 is $700. Is there an arbitrage opportunity? If yes, please specify actions that should be taken to perform the arbitrage (be very specific, indicate all cash flows associated with the arbitrage) and state arbitrage profit. Please provide the solutions to the following questions in the box below. Back up your answers with calculations.
[This is question 2 with the answer]
Q2: Suppose a security generates the following risk free cash flows: $250, $150, and $350 at the end of the first, second and third years after the issuance. Find the securitys fair price at the time of the issue if risk free interest rate is 4%. Please provide the solutions to the following questions in the box below. Back up your answers with calculations.
A: Payment 1 = 250, Payment 2 = 150, Payment 3 = 350, interest = 4%
250*(1/1.04) => 250 * .9615384615 = PV of year 1: $240.38 150* (.9615384615 /1.04) => 150*.924556213= PV of year 2 : $138.68 350* (.924556213/1.04) => 350*.8889963587= PV of year 3 : $311.15 Fair Price = 240.38 + 138.68 + 311.15 = $690.22
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