Question 1. Security A currently sells for $4 and will pay off $5 in a good state of the world next period or $2 in a poor state of the world. Security B sells for $6 and will pay of $7 in a good state next period or $9 in a poor state. Find the no-arbitrage price for Security C if it will pay $24 in a good state next period and $22 in a poor state. After doing so, explain the trade and show the arbitrage profits involved if Security C is currently selling for $21. 2. Two stocks with the same expected cash flow one period from today (after which both stocks will be worthless) of $100 have different levels of systematic risk. Stock A has 1.2 units of systematic risk and is priced at $85 per share while Stock B has 1.5 units of systematic risk and is priced at $87 per share. Briefly describe whether the situation describes is a reasonable situation, and why or why not.
Question
1. Security A currently sells for $4 and will pay off $5 in a good state of the world next period or $2 in a
poor state of the world. Security B sells for $6 and will pay of $7 in a good state next period or $9 in a poor state. Find the no-arbitrage price for Security C if it will pay $24 in a good state next period and $22 in a poor state. After doing so, explain the trade and show the arbitrage profits involved if Security C is currently selling for $21.
2. Two stocks with the same expected cash flow one period from today (after which both stocks will be worthless) of $100 have different levels of systematic risk. Stock A has 1.2 units of systematic risk and is priced at $85 per share while Stock B has 1.5 units of systematic risk and is priced at $87 per share. Briefly describe whether the situation describes is a reasonable situation, and why or why not.
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