Question: Suppose security C has a payoff of $600 when the economy is weak and $1800 when the economy is strong. The risk-free interest rate is

Suppose security C has a payoff of $600 when the economy is weak and $1800 when the economy is strong. The risk-free interest rate is 4%.
a. Security C has the same payoffs as which portfolio of the securities A and B in Problem A.1?
b. What is the no-arbitrage price of security C?
c. What is the expected return of security C if both states are equally likely? What is its risk premium?
d. What is the difference between the return of security C when the economy is strong and when it is weak?
e. If security C had a risk premium of 10%, what arbitrage opportunity would be available?

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a C 3A B b Price of C 3 231 346 1039 c Expected payoff is 6002 18002 1 200 ... View full answer

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