There are two states of economy denoted as state A and B Pri

There are two states of economy denoted as state A and B. Primary security A is priced to be $0.45 and risk free interest rate is 25%. In additoin, HPQ’s stock is forecasted to be either $95 if state A occurs and $65 if state B occurs. What will be the price are you willing to pay for HPQ stock today? What is the price of primary security B?

Solution

Since there are two states of the economy and the primay A is priced at $0.45 (0.45), the primary security B must be priced at 1-0.45 =$0.55 (0.55).

The price of HPQ stock forecast = 0.45*95 +0.55*65 = $78.5

So the price of HPQ stock today = $78.5/(1+0.25) = $62.8

The price of primary security B that should be = 1-0.45 =$0.55 (0.55) as discussed previously.