Suppose you have the following information on asset prices. The inflation rate is 2%. The one period zero-coupon bond with a face value of $100 is sold at a price of $96. There are two states of nature. In state G stock price goes up by 6% and in state B down by 4%. This stock also has a dividend yield of 3%.

(a) Draw the payoff tree for zero-coupon bond and stock in current dollars and in inflation adjusted dollars.

(b) Compute the state price vector (qG,qB) that are consistent with observed asset prices.

(c) Compute the risk neutral probability, G and B , that are consistent with observed asset prices.