PS_06 - Suppose that the world cup soccer nal is 1 year...

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Problem Set 6 Investments Prof. Pierre-Olivier Weill 1. The stock PolarBear.com trades on both the South Pole Stock Exchange and the North Pole Stock Exchange. (a) Suppose the price on the North Pole is \$18. What does the No-Arbitrage Condition say about the price on the South Pole? (Assume no trading costs.) (b) Suppose the price on the North Pole is \$18 and the price on the the South Pole is \$17? How can you make an arbitrage proﬁt? (Assume no trading costs.) (c) Suppose that the price on the North Pole is \$18, that buying or selling on the North Pole costs \$2, and that buying or selling on the South Pole is free. What does the No-Arbitrage Condition say about the price on the South Pole? 2. Suppose that there are two securities RAIN and SUN. RAIN pays \$100 if there is any rain during the next world cup soccer ﬁnal. SUN pays \$100 in there is no rain.
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Unformatted text preview: Suppose that the world cup soccer nal is 1 year from today (although this is not true), and suppose that RAIN is trading at a price of \$23 and SUN is trading at a price of \$70. (a) If you buy 1 share of RAIN and 1 share of SUN, what is your payo after 1 year, depending on the weather? (b) What does the No-Arbitrage Condition imply about the price of a 1-year zero-coupon bond? (Assume no trading costs.) (c) Suppose that a 1-year zero-coupon bond is trading at \$90. Show how you would set up a transaction to earn a riskless arbitrage prot. (Assume no trading costs.) (d) Suppose that trading zero-coupon bonds is costless, but trading RAIN and SUN each cost \$2 per \$100 face value. Can you still make an arbitrage prot?...
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This note was uploaded on 12/04/2011 for the course ECON 106v taught by Professor Miyakawa during the Spring '08 term at UCLA.

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