Suppose initially that two assets, A and B, will each make a single guaranteed p

Question

Suppose initially that two assets, A and B, will each make a single guaranteed payment of $400 in one year. But asset A has a current price of $340 while asset B has a current price of $380. Instructions: Round your answers to 2 decimal places. What are the rates of return of assets A and B at their current prices? Return on asset A = percent Return on asset B = percent. Given these rates of return, which asset should investors buy and which asset should they sell? Buy asset and sell asset Assume that arbitrage continues until A and B have the same expected rate of return. When arbitrage ends, will A and B have the same price? Next, consider another pair of assets, C and D. Asset C will make a single payment of $600 in one year, while D will make a single payment of $800 in one year. Assume that the current price of C is $500 and that the current price of D is $740. What are the rates of return of assets C and D at their current prices? Return on asset C = percent. Return on asset D = percent. Given these rates of return, which asset should investors buy and which asset should they sell? Buy asset and sell asset Assume that arbitrage continues until C and D have the same expected rate of return. When arbitrage ends, will C and D have the same price? Compare your answers to questions a through d before answering question e. We know that arbitrage will equalize rates of return. Does it also guarantee to equalize prices? In what situations will it also equalize prices?

Explanation / Answer

A

Ans:

Return on asset A = 400 = 340(1+r)

1+r = 400/340

.r= 17.65%

Like this

Return on B = 5.26%

Buy asset A and sell asset B.

B)

Ans:

Yes, because demand of A will increase.

C)

Return on c = 20%

Return on D = 8.1%

Buy asset C and Sell Asset D

D)

No because the assets initial price is not same so here only the rate of return equals. to come at the equilibrium.

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