Consider an economy with two stocks. Stock A has a price of $50 today, and will be either $60 or $40 next year, and stock B, with a price of $40, will be either $52 or $28 next year.
- In terms of the finite state economy in Section 16.1, what are the number of assets and states, and what is the payoff matrix?
- With $100 to invest, how do you purchase the equal-weighted portfolio?
- Suppose that there is an 80% chance for the first state (up state) to obtain. What is the expected return and risk of the equal-weighted portfolio?
- Suppose there is in addition a risk-free asset that pays you $105 for sure for a $100 investment. How does that alter your answer to part a?
- Suppose that there is a new stock available that will pay you $250 or $150 next year. Is this stock redundant and if so, why?
- If the new stock in part d has a price of $201 today, is there an arbitrage opportunity and if so why?