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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