# FIN 367 Study Guide - Midterm Guide: Risk Arbitrage, Idiosyncrasy, Portfolio Investment

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6 Nov 2016
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## Document Summary

Simple framework (cid:858)(cid:374)o(cid:449)(cid:859) a(cid:374)d (cid:858)futu(cid:396)e(cid:859) pe(cid:396)iods: finite number of states may occur in the future and finite number of assets available, assets are defined by payoffs. Portfolio construction: form a portfolio by buying wi shares of asset i, the po(cid:396)tfolio(cid:859)s pa(cid:455)offs (cid:894)p(cid:396)i(cid:272)e(cid:895) a(cid:396)e the su(cid:373) of i(cid:374)di(cid:448)idual pa(cid:455)offs (cid:894)p(cid:396)i(cid:272)e(cid:895) Arrow debreu model: under certain economic assumptions, there must be a set of prices where supplies = demands, to calculate prices of all states, we need as many assets as there are states of the world. If we do this, we can construct a-d securities for each state. Risk-free portfolio: portfolio that pays in ever state of the world, buy one of each a-d security to construct a rf portfolio. Rf price = sum of all prices. Rfinterest rate = 1/sum of all prices. State probabilities: pi(s) is the probability of state s. State prices do(cid:374)(cid:859)t ha(cid:448)e to (cid:271)e p(cid:396)opo(cid:396)tio(cid:374)al to p(cid:396)o(cid:271)a(cid:271)ilities.