Consider a two-date economy where there are three states of the world at date 1. There...
Fantastic news! We've Found the answer you've been seeking!
Question:
Transcribed Image Text:
Consider a two-date economy where there are three states of the world at date 1. There is a risky asset and a risk-free asset. The pay-off of the risky stock at date 1 will be $3, $6, or $4, and it trades at the price of $3 today. The risk-free asset pays a net return of 5%. In addition, consider an European call option on the risky asset with a strike price of $4, which currently trades at $0.05. The probabilities of the three states are 0.3, 0.5, and 0.2, respectively. 1. Compute the Arrow-Debreu prices. Is there any arbitrage opportunity in the market? (4pts) 2. Are markets complete? (4pts) 3. Price an European put option on the risky stock with an exercise price of $4 by using the Arrow-Debreu prices. (4pts) 4. Calculate the stochastic discount factor and the risk-neutral probabilities, and price again the put option by using the risk-neutral probability. (4pts) Consider a two-date economy where there are three states of the world at date 1. There is a risky asset and a risk-free asset. The pay-off of the risky stock at date 1 will be $3, $6, or $4, and it trades at the price of $3 today. The risk-free asset pays a net return of 5%. In addition, consider an European call option on the risky asset with a strike price of $4, which currently trades at $0.05. The probabilities of the three states are 0.3, 0.5, and 0.2, respectively. 1. Compute the Arrow-Debreu prices. Is there any arbitrage opportunity in the market? (4pts) 2. Are markets complete? (4pts) 3. Price an European put option on the risky stock with an exercise price of $4 by using the Arrow-Debreu prices. (4pts) 4. Calculate the stochastic discount factor and the risk-neutral probabilities, and price again the put option by using the risk-neutral probability. (4pts)
Expert Answer:
Answer rating: 100% (QA)
1 Arrow Deb re u Prices The Arrow Deb re u prices are the expected pay offs from holding a unit of e... View the full answer
Related Book For
Essentials Of Business Statistics Communicating With Numbers
ISBN: 9780078020544
1st Edition
Authors: Sanjiv Jaggia, Alison Kelly
Posted Date:
Students also viewed these finance questions
-
In an economy there are two states of the world and four assets. You are given the following prices for three of these securities in different states of the world: "Current" prices for A, B, C are...
-
Consider a one-year European call option on a stock when the stock price is $30, the strike price is $30, the risk-free rate is 5%, and the volatility is 25% per annum. Use the DerivaGem software to...
-
A four-month European call option on a dividend-paying stock is currently selling for $5. The stock price is $64, the strike price is $60, and a dividend of $0.80 is expected in one month. The...
-
The standard cost card for Balsam indicates each unit of product should take 1.5 hours of direct labor at a cost of $10 per hour. During the current period, Balsam produced 3,000 units, used 5,000...
-
Walter Manufacturing Co. produces and sells specialized equipment used in the petroleum industry. The company is organized into three separate operating branches: Division A, which manufactures and...
-
Determine the amount of heat (in kJ) given off when 1.26 ( 104 g of NO2 are produced according to the equation? 2NO(g) O2(g) - 2NO2(g) (H = 114.6 kJ/mol
-
A subsidiarys accounts are measured in euros. Assume the leverage ratio is ending total liabilities divided by ending total assets. The current ratio is ending current assets divided by ending...
-
Lowell Companys manufacturing overhead budget for the first quarter of 2014 contained the following data. Actual variable costs were indirect materials $13,900, indirect labor $9,500, utilities...
-
Exercise 11-5 (Algo) Volume Trade-Off Decisions [LO11-5] Outdoor Luggage, Incorporated, makes high-end hard-sided luggage for sports equipment. Data concerning three of the company's most popular...
-
Choice Designs Ltd operates a wholesale/retail carpet store. The statement of financial position of the business as at 31 May Year 8 is as follows: As a result of falling profits the directors of the...
-
10.2 Calculate theweight and angular position of the balancing mass, given r=0.2m. FC3 Balancing mass FC 360 kg FC4 0.25 m 0.15 0.3m 120 255*1145 390 kg S45 FC2 450 kg 0.2 m FC1 300 kg (a) Space...
-
Bouquets (EB) makes and sells flower bouquets. EB is considering opening a new store in the local mall. The mall has several empty shops and EB is unsure of the demand for its product. The mall has...
-
1.What are some of the principal reasons why project management has become such a popular business tool in recent years? 2.Describe the basic elements of the project life cycle. Why is an...
-
The COVID - 1 9 pandemic disrupted traditional business models, prompting a rapid shift towards digitalization, remote work, and online services. Entrepreneurial opportunities emerged in digital...
-
CPA Koby company has revenues of $200000 variable costs of $150000 fixed costs of $60000 and an operating loss of $10000. By how much would Baby need to increase its revenues in order to achieve a...
-
Under the British Columbia Emergency Program Act, created in response to the COVID pandemic, people who organize large, unsafe gatherings or ignore provincial health orders relating to mass...
-
that due to the equilateral-triangular symmetry of the lattice, d1/d2 = sqrt3, exactly. Given this exact value, find the percentage error for your experimental value of d1/d2. Is this percentage...
-
The percentage of completion and completed contract methods are described in the FASB ASC. Search the codification to find the paragraphs covering these topics, cite them, and copy the results.
-
The accompanying table shows a portion of data consisting of the selling price, the age, and the mileage for 20 used sedans. The entire data set, labeled Car_Prices, can be found on the text website....
-
Apple products have become a household name in America with 51% of all households owning at least one Apple product (CNN, March 19, 2012). a. What is the probability that two in a random sample of...
-
Consider a linear regression model where y represents theresponse variable and d1 and d2 are dummy variables. Themodel is estimated as = 160 + 15d1 + 32d2. a. Compute for d1 + 1 and d2 + 1. b....
-
Describe factors that affect your potential earning power.
-
List some of the personal issues you will need to consider when planning your career.
-
Suzanne is a single mother who works full time and pays a sitter to take care of her two children. She recently moved to another state and found a new job. The company offers a variety of employee...
Study smarter with the SolutionInn App