1. The table below shows the no-arbitrage prices of securities A and B. The economy is equally likely to strengthen or weaken in one year. Security A B Market Price Today 231 346 Cash Flow in One Year Strong Economy Weak economy 0 600 600 0 a. What are the payoffs of a portfolio of one share of security A and one share of security B? b. What is the market price of this portfolio? What expected rate of return will you earn from holding this portfolio? c. What is the risk-free interest rate?

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Interest Rate

When you deposit your money with the bank, the deposit earns you some extra money at the end of the specific period – something more than what you deposited. That amount of money that the bank pays you for keeping the money with the bank is the “interest” and the percentage at which the bank pays you for your amount is called the “interest rate”.