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Thread: Arbitrage opportunities help

  1. #1
    Actuary.com - Level I Poster
    Join Date
    Oct 2011
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    Arbitrage opportunities help

    Just wondering can anyone help with this problem? I'm finding it hard to identify arbitrage opportunities and this is a typical question that gets asked in the exam i'm studying for

    Risk-free bonds may be purchased at a cost of $100 (or in fractions if required). They are known to pay off in one year $110 with certainty. All investors can borrow and lend at the riskless rate.
    Shares of the market portfolio may be purchased for $100 each. They are expected to pay off $120 at the end of the year, but there is uncertainty involved. Shares of the market may be purchased and shorted without transactions costs.
    Shares of asset A may be purchased for $100 and they are expected by everyone to be worth $150 at the end of the year. Asset A has a beta of 1.3. As with the market, shares of A may be shorted and purchased without transactions costs.
    How would an investor proceed in an expectations arbitrage?

  2. #2
    Actuary.com - Level III Poster
    Join Date
    Jan 2011
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    195
    Where do you get this problem from?

    How can one get arbitrage opportunities from risky assets? When the price is not certain, there is risk. Moreover, the question does not give us the probability of share prices going up and down.

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