What is the risk-free rate of return in this economy

Reference no: EM132206465

Question - Assume that there are two possible future states of the economy: weak and strong. Two securities, A and B, are available for trading. Prices (at t=0) and future payoffs (at t=1) in both states are given in the following table:

	Price ($) at t = 0	Payoffs ($) at t = 1
	Price ($) at t = 0	Weak state	Strong state
A	30.76	0	200
B	84.67	100	0

Assume that both states are equally likely (50% chance of each). Answer the following questions.

a. There is another security, call it C, whose payoff at t = 1 is equal to $200 in the weak state and $400 in the strong state. Find the no-arbitrage price (at t = 0) of security C.

b. What is the risk-free rate of return in this economy? (Hint: what makes something risk-free? Can you create a portfolio that is risk-free?)

C. Find expected rate of return and expected risk premium for security C from part a.

Reference no: EM132206465

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