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...
-
The budgets of four companies yield the following information: Company Requirements 1. Fill in the blanks for each company. 2. Compute breakeven, in sales dollars for each company. Which company has...
-
Peel Company owns 90% of the common stock of Seacore Company. Seacore Company sells merchandise to Peel Company at 20% above cost. During 2024 and 2025, such sales amounted to $436,000 and $532,000,...
-
What is a gas turbine? What are the essential components of a gas turbine plant? How it differs from a steam turbine?
-
Refer to the Racer Sports Data Set. Racer Sports Company makes snowboards, downhill skis, cross-country skis, skateboards, surfboards, and in-line skates. The company has found it beneficial to split...
-
The big hope housing company uses a predetermined overhead rate to allocate overhead based on Direct Labor cost. This years budget includes Overhead equal to $500,000 and Direct Labor cost of...
-
Daniel Company uses a periodic inventory system. Data for 2015: beginning merchandise inventory (December 31, 2014), 2,000 units at $38; purchases, 8,000 units at $40; expenses (excluding income...
-
On January 1, 2020, Masters, Inc., grants a compensatory share option plan to 15 of its executives. The plan allows each executive to buy 1,000 shares of its $1 par common stock at $30 per share...
-
In 1895 John Deere launched The Furrow magazine in the United States. The content featured in The Furrow was educational, and it focused on teaching farmers how to be more fruitful business owners,...
-
Using backtracking, write a program to find whether a given word can be spelled with symbols for the chemical elements. For example, brother can be spelled as Br O Th Er, the symbols for bromium,...
-
Consider the task of finding numbers in a string. For example, the string In 1987, a typical personal computer cost $3,000 and had 512 kilobytes of RAM. has three numbers. Break this task down into a...
-
The in and out variables of the System class are public static variables of the System class. Is that good design? If not, how could you improve on it?
-
Repeat Exercise E10.8 , making the Measurer into an inner class inside the main method. Data from Exercise E10.8 Using a different Measurer object, process a set of Rectangle objects to find the...
-
Below is Justin Corp's flexible budget and actual results for making 52,000 units. The company's expected manufacturing products in the static budget is 50,000 units. Budget Amt Unit (Batches of 100)...
-
The Zwatch Company manufactures trendy, high-quality moderately priced watches. As Zwatch's senior financial analyst, you are asked to recommend a method of inventory costing. The CFO will use your...
-
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....
-
Refer to requirement 2 of Exercise4.11. Required Prepare summary journal entries for the use of direct materials and conversion costs. Also prepare a journal entry to transfer out the cost of goods...
-
Describe the distinctive characteristic of weighted-average computations in assigning costs to units completed and closing work in progress.
-
Europe Electronics SNC manufactures microchips in large quantities. Each microchip undergoes assembly and testing. The total assembly costs during January 2022 were: Required 1 Assume there was no...
Study smarter with the SolutionInn App