CHE374F-PS04-Sol-2009

# CHE374F-PS04-Sol-2009 - CHE374F PS #4 Solutions 2009...

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CHE374F – PS #4 Solutions – 2009 Question #1: 55 Invest A in the market and B in the risk-free investment: A*65 + B*104 = 120 A*51 + B*104 = 83 A = 2.6429 B = -0.4979 Fair price = 55*A+100*B = 95.5632 Market expected rate of return = 65 .55+51 .45 55 ± - 1 = 6.7273% Cash flow expected rate of return = 120 .55+83 .45 95.5632 ± - 1 = 8.1483% The fair price valuation is independent of the probability of the market going up or down. Market expected rate of return = 65 .6+51 .4 55 ± - 1 = 8% Cash flow expected rate of return = 120 .6+83 .4 95.5632 ± - 1 = 10.0842% 65 51 104 104 100 120 83 ? Market investment Risk free investment Cash flow scenario 55% 45% 55% 45%

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Question #2: Scenario (1): Invest \$1(CAD) at CAD risk-free rate ° = 1 (1 + 3%) Scenario (2): Invest \$.94(USD) at USD risk-free rate and convert it to CAD at the end of the year F = .94 (1+2.5%) °± To avoid arbitrage both investment should have the same value: 1 (1 + 3%) = .94 (1+2.5%)
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## This note was uploaded on 10/18/2010 for the course ENGINEERIN CHE374 taught by Professor Y.lawrynshyn during the Fall '09 term at University of Toronto.

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CHE374F-PS04-Sol-2009 - CHE374F PS #4 Solutions 2009...

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