a) An investor is given the following information:PayoffState 1 State 2SecurityMarket prices(s=1)(s=2)X£15£20PJ = £19Y£25£10PK = £25Explaining the method(s) and the underlining concept(s), how could the investor use Arrow-Debreu pure securities to replicate the payoff of security X and security Y? What are theprices of pure security 1 and pure security 2? b) Explaining the method, compute the capital weights on portfolios of X and Y assets thatreplicate the payoffs of pure securities 1 and 2. Further consider that an investor has aninitial wealth of £1000 - he can short-sell securities; however, he must be able to meet allclaims under the occurrence of either state. Explaining the method, what is the maximumnumber of security Y he could sell (short selling) to buy security X? (investor may buyfractions of shares).

Replicating Payoffs with the Use of Arrow-Debreu Securities: a) Approach and Fundamental…

Answered: a) An investor is given the following…

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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Consider a security that pays income to its holders (e.g., a dividend-paying stock, or acoupon bond). Should the forward price of this security (for a contract that matures attime T), F0,T, be higher than, lower than, or equal to the security's current spot price?Why?.
1. Suppose there are three complex securities and three different states as follows: Security So S₁(1) S₁ (2) S₁ (3) 1.2 3 0 0 1.8 4 2 0 1.2 2 1 1 2 10 4 A B C D (a) Find the arbitrage-free price of asset D. (b) What is the risk-free return compatible with these asset prices?
Question: There are three securities in the market. The following chart shows their possible payoffs: &n... Edit question There are three securities in the market. The following chart shows their possible payoffs: State Probabilityof Outcome Return on Security 1 Return on Security 2 Return on Security 3 1 .14 .199 .199 .049 2 .36 .149 .099 .099 3 .36 .099 .149 .149 4 .14 .049 .049 .199 a-1. What is the expected return of each security? (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) Answer 12.40% a-2. What is the standard deviation of each security? (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) Answer 4.50% b-1. What are the covariances between the pairs of securities? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your…
Suppose you observe the following situation: Security Beta Expected Return Pete Corp. 1.70 0.180 Repete Col 1.39 0.153 What is the risk-free rate? (Do not round intermediate calculations. Round the final answer to 3 decimal places) Risk-free rate % Assume these securities are correctly priced. Based on the CAPM, what is the expected return on the market? (Do not round intermediate calculations. Round the final answers to 2 decimal places.) Expected Return on Market Pete Corp. Repete Co.%
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Suppose you observe the following situation: Security Beta Expected Return Pete Corp. 1.70 0.180 Repete Co. 1.39 0.153 What is the risk - free rate? (Do not round intermediate calculations. Round the final answer to 3 decimal places.) Risk - free rate % Assume these securities are correctly priced. Based on the CAPM, what is the expected return on the market? (Do not round intermediate calculations. Round the final answers to 2 decimal places.) Expected Return on Market Pete Corp. % Repete Co. %
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The market portfolio (M) has the expected rate of return E(rM) = 0.12. Security A is traded in the market. We know that E(rA) = 0.17 and βA = 1.5. (1) What is the rate of return of the risk-free asset (rf)? (2) Security B is also traded in the market. βB = 0.8. Then what is “fair” expected rate of return of security B according to the CAPM? (3) Security C is a third security traded in the market. βC = 0.6, and from the market price, investors calculate E(rC) = 0.1. Is C overpriced or underpriced? What is αC?

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