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# Arbitrage and Financial Decision Making

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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

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