Which of the following statements is implied by the existence of no-arbitrage in a risk-neutral pricing framework?
A)All bonds will have the same expected return irrespective of maturity.
B)Expected long-term bond rates of return will be higher than expected short-term bond rates of return.
C)Each period,bonds of all maturities will have the same expected rate of return.
D)The probability of rates moving up versus moving down is fifty-fifty.

Question

Quizplus · Accepted Answer

Different bonds have different maturities and vary in expected return to maturity,because the maturities are different and the yield curve is not always flat,even though pricing is undertaken under the risk-neutral measure-hence,(a)is not valid.Depending on the slope of the curve,there is no definitive ordering of long- versus short-term rates of return,invalidating (b).Risk-neutral probabilities do not have to be 0.50 for a binomial process,invalidating (d).However,each period,in the risk-neutral framework,all bonds will earn the risk-free rate of return for one period,i.e. ,the short rate.Hence (c)is valid.

Which of the Following Statements Is Implied by the Existence