4. Suppose that we can describe the world using two states and that two assets areavailable, asset K and asset L. We assume the assets' future prices have thefollowing distributions: Contingent Claims and Contingent StrategiesStateFuture Prices Asset KFuture Prices Asset L$25$201$212.$18Let K(1) = $20 denote the time 1 price of asset K and L(1) = $19 the time 1price of asset L.%3Da. Assuming no arbitrage opportunities, what are the values of the unit claimsat time 1?b. What is the risk-free rate of return that must obtain in this market?5.Sunnes

given information K(1) = 20 L(1) = 19 so, we solved the solution from step 2

ontingent Claims and Contingent Strategies State Future Prices Asset K Future Prices Asset L $25 $20 1 $21 $18 Let K(1) = $20 denote the time 1 price of asset K and L(1) price of asset L. a. Assuming no arbitrage opportunities, what are the values of the unit claims at time 1? = $19 the time 1 %3D b. What is the risk-free rate of return that must obtain in this market? Sun

ontingent Claims and Contingent Strategies State Future Prices Asset K Future Prices Asset L $25 $20 1 $21 $18 Let K(1) = $20 denote the time 1 price of asset K and L(1) price of asset L. a. Assuming no arbitrage opportunities, what are the values of the unit claims at time 1? = $19 the time 1 %3D b. What is the risk-free rate of return that must obtain in this market? Sun

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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= 10. Recall that the risk-neutral probability of an asset corresponds to the probability for which the expected return on the asset equals the risk-free rate. Consider a special case where the current asset value is So 100, and the annual risk-free rate is r = = 0%. The asset does not pay dividends. Additionally, consider a simple distribution in which the asset price goes up by $10 with probability p and drops by $10 with probability 1 - p. Based on this information, what is the risk-neutral probability? It (a) 0.55 (b) 0.50 (c) 0.45 (d) 1.00
Consider an economy with a (net) risk-free return r1 = 0:1 and a market portfolio with normally distributed return, with ErM = 0:2 and 2M = 0:02. Suppose investor A has CARA preferences, with risk aversion coe¢ cient equal to 1 and an endowment of 10. a) Write down the maximization problem for the investor. b) Determine the amount invested in the risky portfolio and in the risk-free asset. c) Suppose another investor (B) has a coe¢ cient of absolute risk aversion equal to 2 (and the same endowment 10). Compute his optimal portfolio and compare it to that of investor A. Explain the di§erent results for investors A and B. d) Finally, consider Investor C with mean-variance preferences Ec V ar(c) (and endowment 10). Compute his optimal portfolio and compare it to that of investors A and B (as obtained in questions b and c). Compare your result with those obtained for investors A and B.
Suppose you observe the following situation: Security Beta Expected Return Peat Company 1.70 13.60 Re - Peat Company 0.85 10.80 Assume these securities are correctly priced. Based on the CAPM, what is the expected return on the market? What is the risk - free rate?
Father Time asks us what is the expected return on asset A if it has a beta of .75, the expected market return is 12%, and the risk- free rate is 4%? А. 6.0% В. 6.5 C. 7.0 D. 8.0 E. 10.0
The following payoffs are observed in frictionless markets: Dividend next period Price next period Price today Asset 1 4 84 80 Asset 2 5 105 P2 A. The rate of return on asset 2 equals 5%. B. In the absence of arbitrage opportunities, p2= 100. C. In the absence of arbitrage opportunities, the rate of return on asset 1 equals 8%. D. In the absence of arbitrage opportunities, p2= 110. E. None of the above.
Required Return If the risk-free rate is 10.2 percent and the market risk premium is 4.4 percent, what is the required return for the market? Multiple Choice A. 5.8% B. 4.4% C. 14.6% D. 10.2%
We believe that the single factor model can predict any individual asset’s realized rate of return well. Both Portfolio A and Portfolio B are well-diversified: ri = E(ri) + βiF + Ei, where E(ei) = 0 and Cov(F, i) = 0 A B β 1.2 0.8 E(r) 0.1 0.08 (1) What is the rate of return of the risk-free asset? (2) What is the expected rate of return of the well-diversified portfolio C with βC = 1.6, which also exists in the market? (3) A fund constructs a well-diversified portfolio D. Studies show that βD = 0.6. The expected rate of return of D is 0.06. Is there an arbitrage opportunity? If so, construct a trading strategy to earn profits with no risk. If not, why?
Which of the following is included inthe risk-free rate? O A. the default premium O B. the expected inflation premium O C. the liquidity premium O D. the maturity premium O E. All of the above are included in the risk-free rate. Reset Selection
The expected market return is 5%. The risk-free rate is 3%. According to the CAPM equation, what is the expected return on an asset which has alpha=1.5%, and beta=1.9 ? O a. 11.0% O b. 5.3% O c. 5% O d. 6.8% O e. 8.3%
What is the expected market return if the expected return on asset A is 19% and the risk free rate is 5%? Asset A has a beta of 1.4. Assume that the CAPM is correct. a. 5% b. 9% c. 13% d. 15% e. 19%
What is the expected return on asset A if the expected return on the market is 8%, the risk-free rate is 4%, and the Beta of asset A is 2? You want to use Capital Asset Pricing Model (CAPM) Group of answer choices A) 12% B) 20% C) 16%
Which asset in the following table has the most market risk (also known as systematic or non-diversifiable risk)? (Ch. 8) Asset Return Beta Standard Deviation Asset A 9% 0.95 20% Asset B 13% 1.10 35% Asset C 10% 1.00 40% Group of answer choices Asset A Asset C Asset B and Asset C Asset B

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