1. (21 points) The risk free rate is 1% and there are two securities that allow you to bet on the outcome of an election in 3 months time. Security A…

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1. (21 points) The risk free rate is 1% and there are two securities that allow you to bet onthe outcome of an election in 3 months time. Security A pays $1 if candidate A wins and50.1 if he loses, security B pays $1 if candidate B wins and $01 if she loses. Only candidate A or B can win. a. How much are risk-averse investors willing to pay today for the two securities A and B in a competitive market? Explain your answer. b. When would there be arbitrage opportunities?c. Devise and describe a trading strategy with market orders that takes advantage of arbitrage opportunities when they arise; assume you pay a per—securitycommission of $0.001. in particular, describe carefully the position that you want to establish and the conditions that must hold for you to establish a position. 2. (16 points) You have access to a savings account that pays you an annuai rate of interestof 2%, and for which interest is paid out every week (in same manner as in cases F|1,F|2, and Fl4). Furthermore, there is a three—month T-Biil. a. Describe a strategy that takes advantage of arbitrage opportunities using limitorders during the first 2 weeks after the issue of the T—Bill.b. Provide the VBA code for your strategy in a. (Note: Common RIT commands are listed on the last page of the exam script). 3. (21 points) You are the market maker for ETF AB. This ETF tracks an index that is the sumof the prices of stocks A and B (i.e., if A trades at $10, and B at $20, the index value is $30).-There is only one exchange. Take the bid and ask prices forthe underlying stocks as given. a. Your task is to continually post limit orders for the ETF. Describe your strategy.b. In addition to making the market, you have been tasked to be fully hedged. That is, ifyou are short in the ETF (because you provided liquidity), you need to be long in the underlying. Describe how this requirement changes your strategy in 1.c. Now suppose you are not the oniy one posting iimit orders. What kind of arbitrage opportunities could arise and how would you take advantage of them?

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