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    Risk-neutral probability

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    At time 0.5, the price of $1 par of a zero maturing at time 1 will be either $0.96 or $0.98. The risk-neutral probability of the each outcome is 50%. The current price of $1 par of a zero maturing at time 0.5 is 0.97.

    Time 0 Time 0.5
    Zero maturing at time 0.5 0.97 0.96
    Zero maturing at time 1 ?
    What is the price at time 0 of the zero maturing at time 1 in the absence of arbitrage?
    Multiple choice question. Pick one answer.

    Question: Which of the two zeroes above has the higher true expected return from time 0 to time 0.5?

    Answer 1: The 0.5-year zero.
    Answer 2: The 1-year zero.
    Answer 3: They have the same true expected return.
    Answer 4: There is not enough information provided to tell.

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