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Securities

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Consider two securities that pay risk-free cash flows over the next two years and that have the current market prices shown here:

Security Price Today ($) Cash Flow Cash Flow
in One Year ($) in Two Years ($)
______________________________________________________________________
B1 94 100 0
B2 85 0 100

1) What is the no-arbitrage price of a security tht pays cash flows of $100 in one year and $100 in two years?

2) What is the no-arbitrage price of a security tht pays cash flows of $100 in one year and $500 in two years?

3) Suppose a security with cash flows of $50 in on year and $100 in two years is trading for a price of $130. What arbitrage opportunity is available?

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Solution Preview

Please see the attachment for solution.

1) What is the no-arbitrage price of a security that pays cash flows of $100 in one year and $100 in two years?

The no-arbitrage price of a security that pays cash flows of $100 in one year and $100 in two years = 94 +85
= $179 (since this is ...

Solution Summary

The solution discusses the determination of the no-arbitrage price of a security.

$2.19
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