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Question 55 Suppose you live in the Fama-French three-factor model world. Goldman Sachs...

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Finance

Question 55

  1. Suppose you live in the Fama-French three-factor model world. Goldman Sachs is selling two derivative securities to your company. Both will pay 100 million dollars over a 10 year period. Assuming that there is no time value of money (i.e., the time value of money is zero).

    Security A will pay out the cash smoothly over the 10-year period, with payment equal to 10 million dollars each year.

    Security B will pay out cash that is positively correlated with economic indicators, thus paying out more when economy is booming and less when economy is tanking.

    What should be the fair valuation of these two securities at the start of this 10 year period.

    Security A's price should be less than 100 million. Security B's price should have the same as A.

    Security A's price should be 100 million. Security B's price should be more than 100 million.

    Security A's price should be equal to 100 million. Security B's price should have lower than 100 million.

    Security A's price should be more than 100 million. Security B's price should be more than 100 million.

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