There is one future period with two possible states . A share returns 5 in and in , priced at 3. A government bond returns 1 in each state, priced at 1. A third asset returns 3 in and 0 in . If the price of the new asset rules out arbitrage (which arises when portfolios identical in returns have different prices), what is the price of the new asset?
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There is one future period with two possible states s₁,s₂. A share returns 5 in s₁ and -1 in s₂, priced at 3. A government bond returns 1 in each state, priced at 1. A third asset returns 3 in s₁ and 0 in s₂. If the price of the new asset rules out arbitrage (which arises when portfolios identical in returns have different prices), what is the price of the new asset? (A) It depends on the probabilities of the future states (B) Strictly between 2 and 3 (C) Strictly between 1 and 2 (D) 2
Also written as: There is one future period with two possible states s_1,s_2. A share returns 5 in s_1 and -1 in s_2, priced at 3. A government bond returns 1 in each state, priced at 1. A third asset returns 3 in s_1 and 0 in s_2. If the price of the new asset rules out arbitrage (which arises when portfolios identical in returns have different prices), what is the price of the new asset?
Time value of money and bond pricing has come up 20 times in 5 exams since 2010.
This question is on Bond prices, yields and no-arbitrage, part of Time value of money and bond pricing in Macroeconomics.
How bond prices move with interest rates and what ties asset returns together.
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Question from the DSE 2010 paper. Solutions are TestStop's own. Not affiliated with or endorsed by any examination authority.