Finance Assignment Solution: Equilibrium, Options, and Pricing

This finance assignment solution addresses key concepts in financial markets, including equilibrium prices and option pricing. The solution begins by defining terms like equilibrium price, call options, and put options, providing clear explanations of each. It then delves into a specific problem involving a state price vector, calculating the price of a call option and a put option using the given parameters. The solution demonstrates the application of financial models and formulas to real-world scenarios. The assignment also includes references to relevant financial literature, providing additional context and resources for further study. This document is a valuable resource for students studying finance, offering a practical understanding of core concepts and their application in financial analysis.

Running Head: Finance
Finance
Student’s Name
Supervisor’s Name
Institutional Affiliation
Date

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Definition of Terms
Equilibrium price can be defined as the market price in which the supplied goods are
totally equal to the goods in demand. When a graph of price against quantity is drawn, the point
at which supply and demand curves intersect is the equilibrium price.
A call option on a security is an agreement that provides the choice buyer the correct, to buy a
bond, commodity, a stock, but not limited to obligation. It gives the holder the chance to buy
hundred percent shares of an original stock at a given specific price. The underlying price is
called the strike price.
A put option on Security is a choice agreement that gives the owner the right to sell a definite
volume of an underlying security at a given price within a stipulated period of time.
We simply need to check whether D’Ψ = p has a positive solution.
D= [20 44 12
48 36 12 ]
[20 48
44 36
12 12 ][24
40
12 ] ¿
Ψ = [1 /4, 1/4, 1/2], so a state price vector exists. The equilibrium price measures, there is only
one unique EPM and because rf = 0, the EPM is equivalent to Ψ.
(a) A call option on security 1 with an exercise price of 25.

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The payo s of this option are given by X = [0, 0, 23]. Using the state price vector Ψ foundff
above, the price of X is P(X) = X ·Ψ = 23/2.
(b) A put option on security 2 with an exercise price of 40.
The payo s for this choice is given by X = [4,4,0]. Now, computing using the state price vectorff
Ψ found above, the price of X is P(X) = X ·Ψ = 2.

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References
Beghin, J. & Beladi, H. (2013). Nontariff measures with market imperfections: trade and welfare
implications. Bingley, U.K: Emerald.
Rosen, L. (1974). How to trade, put, and call options: the new and proven way to stock market
profits. Homewood, Ill: Dow Jones-Irwin.
Vries. (2010). Measuring and explaining house price developments. Amsterdam: IOS Press
Salopek, D. (1997). American put options. Harlow, Essex, England: Longman.

Finance