At Time 0, asset ABC is selling for $85 and XYZ is selling for $41. These assets’ prices at Time 1 are given under two states of the economy (refer…

  1. At Time 0, asset ABC is selling for $85 and XYZ is selling for $41. These assets’ prices at Time 1 are given under two states of the economy (refer to Figure 1.1 below). Assume “short selling” is allowed. That is, you can borrow units of ABC and/or XYZ from your broker. Using the concept of “Arbitrage and the Law of One Price” discussed in class, show how you can make a riskless profit.

           Figure 1.1

           Time 0                                                                        Time 1

                                                                                   (1) State: GOOD

                                                                                       ABC=$100

                                                                                       XYZ=$ 50

ABC=$85

XYZ=$41

                                                                                  (2) State: BAD

                                                                                       ABC=$ 80

                                                                                       XYZ=$ 40

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