sider a security that pays income to its holders (e.g., a dividend-paying stock, or a coupon bond). Should the forward price of this security (for a contract that matures at time T), F0,T, be higher than, lower than, or equal to the security's current spot price? Why?.
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Consider a security that pays income to its holders (e.g., a dividend-paying stock, or a
coupon bond). Should the forward price of this security (for a contract that matures at
time T), F0,T, be higher than, lower than, or equal to the security's current spot price?
Why?.
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Solved in 2 steps
- 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?If a security is underpriced (i.e., intrinsic value > price), then what is the relationship between its market capitalization rate and its expected rate of return?Can a derivative security's value be determined by an underlying single stock (e.g., IBM, MMM, GE)? If no, explain. Can a derivative security's value be determined by an underlying fixed income index? If yes, explain. What is the difference objective, if any, between a long futures contract, a put option contract, and a long forward contract? What are the two primary functions of derivative securities (i.e., what classifications of participants do they serve)? Finally, what does "market efficiency" suggest? Explain the significant advantage and disadvantage of Inflation Protected Treasury Bonds (TIPS). Who or what investor would likely prefer a municipal bond issued by the Commonwealth of Virginia? If a corporate bond yields 8%, to be competitive (e.g., indifferent), what would a municipal bond need to yield for an investor in the 40% tax bracket? In municipals, what, if any, is the difference between a general obligation and revenue bond? What is a pass-through security, a conforming…
- What is the relation between the expected rate of return and the required rate of return as they pertain to the fair market price and the current market price of a security?The maximum rate of return needed to induce an investor to purchase or hold a security is referred to as the investor's required rate of return. OTRUE. FALSEThe no-arbitrage price of Security C?
- Explain clearly what should happen to a security’s nominal interest rate as the security’s liquidity risk increases?) Discuss and compare the three explanations for the shape of the yield curve with the figure.According to the capital-asset pricing model (CAPM), a security's expected return is equal to the risk-free rate plus a premiumWhat happens to the price and return of a security when investors recognize it as undervalued? Explain.
- Suppose that C is the price of a European call option to purchase a security whose present price is S. Show that if C>S then there is an opportunity for arbitrage (ie. riskless profit). Assume the interest rate r=0 so present value calculations are unnecessary.What is the Security Market Line (SML)? How isbeta related to a stock’s required rate of return?(I) The market price of a security at a given time is the highest value any investor puts onthe security. (II) Superior information about a security increases its value by reducing its risk.a) (I) is true, (II) is false.b) (I) is false, (II) is true.c) Both are true.d) Both are false.