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Consider two non dividend-paying stocks: Stock A and Stock B
Consider two non dividend-paying stocks: Stock A and Stock B. The next year there can be two states of the economy - State 1 and State 2 - that are equally likely. The two stocks are the only assets on the market and they have the same market capitalization. All investors are risk averse. The values of the stocks in one year, in both States, are reported in the table below: State 1 50 100 State 2 100 Stock A (Price in one year) Stock B (Price in one year) 50 If Stock B price today is 73, what is the return of a risk-free bond?
Expert Solution
Return of risk free bond is given as=(probability of State 1*Value in State 1+probability of State 2*Value in State 2)/Price-1=(0.5*100+0.5*50)/73-1
=2.7397%
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