"In a two-state world, where there are only two possible payoffs on a share of stock at the end of a year, the stock payoffs can be exactly duplicated using a combination of a call option on the stock and risk-free asset."
A risk-free asset is one with a guaranteed future return and almost little chance of loss.
Bonds, notes, and particularly Treasury bills are issued by the U.S. Department of the Treasury.
These are regarded as risk-free investments because they are backed by the "full faith and credit" of the American government.
The return on risk-free assets is very close to the present interest rate because they are so safe.
Therefore "In a two-state world, where there are only two possible payoffs on a share of stock at the end of a year, the stock payoffs can be exactly duplicated using a combination of a call option on the stock and risk-free asset."
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