3-8. The promised cash flows of three securities are listedhere. If the cash flo

Question

3-8. The promised cash flows of three securities are listedhere. If the cash flows are risk free, and the risk-freeinterest rate is 5%, determine the no-arbitrage price of eachsecurity before the first cash flow is paid.

Security

Cash Flow Today ($)

Cash Flow in One Year ($)

A

500

500

B

0

1000

C

1000

0

Security

Cash Flow Today ($)

Cash Flow in One Year ($)

A

500

500

B

0

1000

C

1000

0

The promised cash flows of three securities are listedhere. If the cash flows are risk free, and the risk-freeinterest rate is 5%, determine the no-arbitrage price of eachsecurity before the first cash flow is paid.

Explanation / Answer

Security Cash Flow Today ($) Cash Flow in One Year($)    PV factor at 5% PV of cashflow in 1year($) Price of the Security ($) A 500.00 500.00 0.952 476.00 500 + 476 = 976 B 0.00 1000.00 0.952 952.00 0 + 952 = 952 C 1000.00 0.00 0.952 0.00 1000 + 0 = 1000 Security Cash Flow Today ($) Cash Flow in One Year($)    PV factor at 5% PV of cashflow in 1year($) Price of the Security ($) A 500.00 500.00 0.952 476.00 500 + 476 = 976 B 0.00 1000.00 0.952 952.00 0 + 952 = 952 C 1000.00 0.00 0.952 0.00 1000 + 0 = 1000

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