Suppose there is an ideal bank with effective spot rate function satisfying R*(1) = .04 and...

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Suppose there is an ideal bank with effective spot rate function satisfying R*(1) = .04 and R (2) = .07. Consider the following two fixed income securities: V¹: This security makes a payment of $429.16 at t = 1 and a payment of $100 at t = 2. V2: This security makes a payment of $156.65 at t = 1 and a payment of $400 at t = 2. (a) Determine the arbitrage-free price for each of these securities. Are they the same? (b) Determine the effective yield to maturity (internal rate of return) for each of these securities. Are they the same? Is this surprising? Suppose there is an ideal bank with effective spot rate function satisfying R*(1) = .04 and R (2) = .07. Consider the following two fixed income securities: V¹: This security makes a payment of $429.16 at t = 1 and a payment of $100 at t = 2. V2: This security makes a payment of $156.65 at t = 1 and a payment of $400 at t = 2. (a) Determine the arbitrage-free price for each of these securities. Are they the same? (b) Determine the effective yield to maturity (internal rate of return) for each of these securities. Are they the same? Is this surprising?

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a To determine the arbitragefree price for each security we need to discount each cash flow back to ... View the full answer