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Arrow-Debreu Pricing

a. What is the minimum number of Arrow-Debreu states needed to price: (i) a stock, (ii) a government bond, (iii) an at-the-money vanilla call on the stock, and (iv) a slightly out-ofthe-money vanilla put on the stock? CIRCLE ONE: 1 2 3 4 5 Impossible to answer

b. You are evaluating a really great stock with a current market price of $50. Over the next year, this stock could either double in value, or quadruple in value. Or it can go bankrupt. You can buy bankruptcy protection today for $0.50; this protection would pay you $1 in case the stock is worthless, and of course it pays you nothing if the stock doubles or triples.

The risk-free interest rate is 10%.

i. What is the probability of bankruptcy?

ii. What is the probability that the stock doubles?

iii. What is the probability that the stock quadruples?

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Financial Management, Finance

Category:- Financial Management
Reference No.:- M92772312

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