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Gephardt, Armey and Gore

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13. Gephardt, Armey and Gore, a vaudeville booking agency, has issued zero-coupon corporate debt this week, consisting of 80 bonds, each with a face value of $1,000 and a term to maturity of one year. Industry analyst predict that the value of GAG assets will be $160,000 in one year if Rupert Murdoch succeeds in purchasing and converting the Washington Press Club to a comedy venue, $130,000 if Murdoch buys the comedy venue in Washington. Industry analysts also predict that the aggregate value of the assets of a second firm in the field of comedy entertainment, Yeltsin Yuks, Ltd., will have the values of $100,000, and $100,000, and $40,000, in the there respective circumstances. Assuming that investors can purchases portfolios comprised of shares of the assets of GAG and YY Ltd., as well as buying or short-selling one year, zero coupon, government bonds at the risk less annual rate .10, then:

a. Infer the three alternative values for aggregate values for aggregate equity in GAG, one year from today.
b. Devise a portfolio that is a perfect substitute for the payoffs given by a portfolio composed only of equity in GAG.
c. Determine the current market value of a share of equity in GAG, assuming 10,000 shares of GAG stock are outstanding, the current market value of GAG assets is $120,000, and the current market value of YY Ltd. Assets is $85,725.
d. Determine the current market value of a bond issued by GAG, assuming 80 bonds are issued, under these circumstances. What is the yield to maturity on each such bond?

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