In the next period, the economy can be in either state 1 or state 2, with a probability of 50 percent. You may trade any combination, including fractions of shares, of the following three securities:

a. Are these securities correctly priced? If not, why not? (Hint: set up a portfolio with proper weight in MCD and SB so that the portfolio has the same payoff as security BK.)
b. If there is an arbitrage opportunity, explain how you would exploit it.
c. What is the maximum you would be willing to pay for SB?

  • CreatedFebruary 25, 2015
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