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  3. 2 let btt be the cost at time t of...

Question: 2 let btt be the cost at time t of...

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2. Let B(t,T) be the cost at time t of a risk-free dollar at time T. (a) Suppose B(0,1), B(0,2) and B(1,2) are all known at time 0 (i.e. interest rates are deterministic). Show that the absence of arbitrage requires B(0, 1)B(1,2) B(0,2) (b) Now suppose B(0, 1) and B(0, 2) are known at time 0 but B(1,2) will not be known until time 1. What goes wrong with your argument for (a)? Show that if we know with certainty that m s B(1,2) S M then we can still conclude mB(0,1) S B(0,2) s MB (0, 1)

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