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Suppose there are three states of the world: bad, medium and good

A Stock has payoffs equal to (80, 102, 130) in the three states, respectively.

A Bond has payoffs equal to (95, 103, 105) in the three states, respectively.

The stock is selling for $100 while the bond is selling or $98.

What portfolio of Arrow-Debreu securities would yield the same payoffs as the stock? z₁ =

z₂ =

z₃ =

2. What portfolio of Arrow-Debreu securities would yield the same payoffs as the bond? z₁ =

z₂ =

z₃ =

4. Suppose A-D securities prices = (q₁, q₂, q₃) were again equal to (0.5, 0.005, 0.4). In problem #1, you found the number of A-D securities that would yield the same payoff as the stock. What would be the value of this portfolio of A-D securities if the A-D securities prices were as given in this problem? [value]

Using Solver, find the set of A-D security prices implied by stock and bond prices. Assume that q₁ = 0.5, but you have to find q₂ and q₃. (Hint: Your choice variables would be three cells, each containing a different A-D security price. Your objective function would be setting the value of the A-D securities comprising the portfolio yielding the stock payoffs equal to the stock price. Then you would add one additional constraint for the bond price equaling the value of A-D securities portfolio that yield the bond payoffs.)

q₁ = 0.5

q₂ =

q₃ =

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