A prediction market is an exchange where participants can buy and sell contracts whose payoffs are determined by the outcome of events. The University of Iowa’s Tippie College of Business operates one such exchange, called Iowa Electronic Markets (IEM). For example, it started trading the following contracts based on the outcome of the 2016 US presidential dection in November 2014: • DEM18_WTA : 81 if the Democratic Party nominee receives the majority of popular votes cast for the Iwo major parties in the 2016 U.S. Presidential election, 80 otherwise • REP 10 WTA :81 if the Republican Party nominee receives the majority of popular votes cast for the Iwo major parties in the 2010 U.S. Presid election, 80 otherwise Assume there are only 2 parties and that the winner of the popular vote gets elected president. (1) On 31 July 2015 ( which we will call “today” ) , you observe that the market price of DEMI6_WTA is 58 cents. Also you can invest SI today in risk-free bonds to give 81.05 by the time election results are determined, what should be the price of REPI6_WTA today ? (2) The Republican candidate is friendlier to business, and believes in lowering tax rates. There is a firm which the market believes would be worth S200mn if the Republican candidate wins; and S120mn if the Democratic candidate wins. What should be the firm’s price today ? (3) Suppose you are considering buying a contract, which gives you the right, but not the obligation to buy the firm for 8150 inn. What would such a contract be worth today ?