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Solve the following problem:

Consider two securities that pay risk-free cash flows over the next two years and that have the current market prices show here:

Security Price Today Cash Flow in One year Cash Flow in Two years

B1 94 100 0

B2 85 0 100

a. What is the no-arbitrage price of a security that pays cash flows of $100 in one year and $100 in two years?

b. What is the no-arbitrage prices of a security that pays cash flows of $100 in one year and $500 in two years?

c. Suppose a security with cash flows of $50 in one year and $100 in two years is trading for a price of $130. What arbritrage opportunity is available?

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Q: What is Arbitrage pricing model?
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What is arbitrage process?

Arbitrage is process of utilising differences in price in two markets to make financial gains. Generally each market has a different demand-supply position and hence price of same product is different in different market.


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