Homework Answers
answer a) Returns in different sates are
State 1: 1/3*-2+2/3*4= $2
State 2:1/3*8+2/3*-1 = $ 2
Answer b) By making investment of 0.5 million in the portfolio arrangement , the net outcome will be
0.5*(1/3*A+2/3*B) = 0.5*2 = $ 1 million
So, the investor remain solvent in each state of world.
At end of year , total again = earning - loan repaid = [0.5+0.5*(1/3*A+2/3*B) -1] =$ 0.5 Million.
Answer c) I made this investment to earn arbitrage profit of 0.5 million , as rational investors.
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