Consider the probability space= {w, W2, W3], with the probability P such that P({w}) = 1/3...
Fantastic news! We've Found the answer you've been seeking!
Question:
Transcribed Image Text:
Consider the probability space= {w₁, W2, W3], with the probability P such that P({w}) = 1/3 for every wen. Define the random variables Consider the one-period trinomial model of the market (B, S) made of a bond B with initial price 1 (all prices in a fixed currency, say £), and interest rate r = 1, a stock whose initial price is So 4, and whose final price is S₁. In the questions (a-e) we consider the market model (B, S), and the random variables X₁ and Y₁ represent the payoffs of two illiquid derivatives (with S as underlying); in question (f) Y₁ represents instead the value at time 1 of a traded asset, which is part of the market model (B, S, Y). W1 W2 W3 S₁ (w) 6 X₁(w) -6 8 10 4 14 Y₁(w) 16 6 2 (a) Is the market model (B, S) free of arbitrage? A. No B. Yes (b) Is X₁ replicable? A. No B. Yes (c) Is Y₁ replicable? A. No B. Yes (d) What is the set of arbitrage-free prices of X₁? A. (2,4) B. [2,4] C. {4} D. {2} E. None of the above (e) What is the set of arbitrage-free prices of Y₁? A. (3,9/2) B. (6,9) C. {3} D. {6} E. None of the above (f) Now enlarge the (B, S) market, by assuming that Y is traded at the arbitrage-free price Yo at time 0. If an illiquid derivative has a payoff Z₁ which is not replicable using only bonds and stocks (i.e. Z is not replicable in the (B, S) market), does Z₁ have a nique arbitr e-fre price in the market (B, A. Not enough info to answer (it depends on Z₁) B. No C. Yes Consider the probability space= {w₁, W2, W3], with the probability P such that P({w}) = 1/3 for every wen. Define the random variables Consider the one-period trinomial model of the market (B, S) made of a bond B with initial price 1 (all prices in a fixed currency, say £), and interest rate r = 1, a stock whose initial price is So 4, and whose final price is S₁. In the questions (a-e) we consider the market model (B, S), and the random variables X₁ and Y₁ represent the payoffs of two illiquid derivatives (with S as underlying); in question (f) Y₁ represents instead the value at time 1 of a traded asset, which is part of the market model (B, S, Y). W1 W2 W3 S₁ (w) 6 X₁(w) -6 8 10 4 14 Y₁(w) 16 6 2 (a) Is the market model (B, S) free of arbitrage? A. No B. Yes (b) Is X₁ replicable? A. No B. Yes (c) Is Y₁ replicable? A. No B. Yes (d) What is the set of arbitrage-free prices of X₁? A. (2,4) B. [2,4] C. {4} D. {2} E. None of the above (e) What is the set of arbitrage-free prices of Y₁? A. (3,9/2) B. (6,9) C. {3} D. {6} E. None of the above (f) Now enlarge the (B, S) market, by assuming that Y is traded at the arbitrage-free price Yo at time 0. If an illiquid derivative has a payoff Z₁ which is not replicable using only bonds and stocks (i.e. Z is not replicable in the (B, S) market), does Z₁ have a nique arbitr e-fre price in the market (B, A. Not enough info to answer (it depends on Z₁) B. No C. Yes
Expert Answer:
Answer rating: 100% (QA)
a The market model B S is free of arbitrage since there is no way to c... View the full answer
Related Book For
Microeconomics An Intuitive Approach with Calculus
ISBN: 978-0538453257
1st edition
Authors: Thomas Nechyba
Posted Date:
Students also viewed these finance questions
-
An individual is indifferent among the combinations of public and private goods shown in the following table. Draw the individual's indifference curve. Assuming that the economy can produce one unit...
-
Does the number of commercials shown during a half-hour television program affect how viewers rate the show? In a preliminary study eight people were asked to watch a pilot for a situation comedy and...
-
Mickley Corporation produces two products, Alpha6s and Zeta7s, which pass through two operations, Sintering and Finishing. Each of the products uses two raw materials-X442 and Y661. The company uses...
-
Codominance observable effect on the phenotype of a heter neither allele is recessive-both alleles are dominant. 6. Which of the genotypes results in a blood type that provides clear evidence of...
-
Look at the two normal curves in Figures 6-12 and 6-13. Which has the larger standard deviation? What is the mean of the curve in Figure 6-12? What is the mean of the curve in Figure 6-13? Figure...
-
Cove Resort Corp. issued a 20-year, 7%, $240,000 mortgage note payable to finance the construction of a new building on December 31, 2017. The terms provide for semi-annual instalment payments on...
-
State a conclusion. Exercises 49 refer to the following data: Electric motors are assembled on four different production lines. Random samples of motors are taken from each line and inspected. The...
-
Can a creditor of both the husband and wife under the same obligation obtain an execution against a Winnebago mobile home owned by the husband and wife in tenancy by entirety?
-
Discuss what credit risk means for a commercial bank and how its addresses and manages it. Give an example of credit risk which a commercial bank faces.
-
Suppose that TechnoTCL is considering a new project. They are trying to determine the required rate of return for their debt and equity holders. See the information below: A 6 . 5 % ?percent annual...
-
KRJ Enterprises just reported sales of $404 million, earnings before income taxes of $102.4 million, and tax expense of $18.2 million. If sales are projected to increase by 3.8% next year, what would...
-
Fractional composition in a diprotic system. Create a spreadsheet with Equations 9-19 through 9-21 to compute the three curves in Figure 9-4. Plot the three curves in a beautifully labeled figure....
-
Figure 18.4 shows the call theta as a function of time to maturity. Produce a similar graph for puts. Call Theta, Time to Maturity, and Moneyness 01 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0 Time to optlon...
-
Use the function VanillaCall defined in the chapter to create a Data Table in which you can see the relation between the number of runs incorporated in the function and the Black-Scholes value of a...
-
What document must companies prepare and make available to investors when issuing stocks for the first time? a. A prospectus b. An initial public offering c. Proprietary underwriting d. Investor...
-
Discuss the pros and cons of reporting contractual adjustments directly on the monthly fi nancial reports at the department level.
-
Let f(z) = Find x78 | (x-y) - Jay:) if mxy+ (0,0) x++y2 if (x, y) = (00) O OfZEC if is @SZEC: f is [ZEC : f is continuous at z diff at z} } analytic at z
-
Prove the following D,(cos x) = - sin x (Hint: Apply the identity cos(A + B) = cos A cos B sin A sin B)
-
Suppose you are asked to model the savings decisions of a household that has an income of $100,000 this year but expects to have no income a period into the future. A. Suppose the interest rate is...
-
Every Thanksgiving, my wife and I debate about how we should prepare the turkey we will serve (and will then have left over). My wife likes preparing turkeys the conventional way roasted in the oven...
-
Suppose again, as in exercise 24.5, that two players have $100 to split between them. A: But now, instead of one player proposing a division and the other accepting or rejecting it, suppose that...
-
The following table is a life table, reproduced from the chapter introduction. With an understanding of some basic concepts of probability, one can use the life table to compute the probability that...
-
In Example 5.4, what is the probability that the oldest child and the youngest child are of the same gender? Example 5.4 Computing probabilities A family has three children. Denoting a boy by B and a...
-
A quiz consists of three truefalse questions and two multiple-choice questions with five choices each. How many different sets of answers are there?
Study smarter with the SolutionInn App