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Arbitrage and Financial Decision Making

6. Suppose the risk-free interest rate is 4%.

a. Having $200 today is equivalent to having what amount in one year?

b. Having $200 in one year is equivalent to having what amount today?

c. Which would you prefer, $200 today or $200 in one year? Does your answer depend on when you need the money? Why or why not?

8. Your firm has a risk free investment opportunity where it can invest $160,000 today and receive $170,000 in one year. For what level of interest rates is this project attractive?

12. Suppose Bank One offers a risk-free interest rate of 5.5% on both savings and loans, and Bank Enn offers a risk-free interest rate of 6% on both savings and loans.

a. What abitrage opportunity is available?

b. Which bank would experience a surge in the demand for loans? Which bank would receive a surge in deposits?

c. What would you expect to happen to the interest rates the two banks are offering?

15. The promised cash flow of 3 securites are listed below. If the cash flows are risk-free, and the risk-free interest rare is 5%, determine the no-arbitrage price of each security before the first cash flow is paid.

Security Cash Flow Today($) Cash Flow in 1 Year ($)

A 500 500

B 0 1000

C 1000 0

Solution Preview

Answer:
6. We have,
Risk free interest rate=4%
(a) PV=$200
Time to maturity=1 year
Hence,

(b) FV=$200
Time to maturity=1 year
Hence,

(c) I would prefer $200 today. It depends on the time value of money. The value of the money increase ...

Solution Summary

The calculations and solutions for this problem set are included in an attached Word document.

$2.19