We know the prices and payoffs for securities 1 and 2 and they are represented as follows:

Cash Flow in One Year

Security

Market Price Today

Weak Economy

Strong Economy

1

$ 70

$70

$ 0

$0

$ 175

$175

2

$ 90

$90

$ 175

$175

$ 0

$0

a. What is the risk-free interest rate?

b. Consider a risk-free security that has a payoff in one year of

$ 2 comma 250

$2,250.

i. How many units of each of securities 1 and 2 would be needed to replicate this risk-free

security?

ii. Based on part b.i), what is the market price today of this risk-free security?

iii. Based on part a), what is the market price today of this risk-free security?

c. Consider a security that has a payoff in one year of

$ 2 comma 250

$2,250 if the economy is weak and

$ 4 comma 500

$4,500 if the economy is strong.

i. How many units of each of securities 1 and 2 would be needed to replicate this

security?

ii. Based on part c.i), what is the market price today of this security?

d. Consider a security that has a payoff in one year of

$ 4 comma 500

$4,500 if the economy is weak and

$ 2 comma 250

$2,250 if the economy is strong.

i. How many units of each of securities 1 and 2 would be needed to replicate this

security?

ii. Based on part d.i), what is the market price today of this security?

e. Explain the economic reasoning as to why the security in part c) has a lower price than the security in part d).

a. What is the risk-free interest rate?

The risk-free interest rate is

nothing

%. (Round to four decimal places)

b.i. Consider a risk-free security that has a payoff in one year of

$ 2 comma 250

$2,250. How many units of each of securities 1 and 2 would be needed to replicate this risk-free security?

The units of security 1 needed to replicate the payoff of the new security in the strong economy is

nothing

. (Round to the nearest integer).

The units of security 2 needed to replicate the payoff of the new security in the weak economy is

nothing

. (Round to the nearest integer).

b.ii. Based on part b.i), what is the market price today of this risk-free security?

The market price today of the new risk-free security is $

nothing

. (Round to the nearest dollar).

b.iii. Based on part a), what is the market price today of the new risk-free security?