a) What is the law of one price? Explain how its violation can lead to arbitrage...

a) What is the law of one price? Explain how its violation can lead to arbitrage opportunities?

Expert Solution

Law Of One Price states that an identical product should be priced the same across the world assuming that currency exchange rates remain equal,the market does not have any restriction with regard to import and export ,transportation cost does not apply and the prices remain flexible(not influenced by the buyers an sellers). The violation of law of one price will lead to arbitrage opportunities.Arbitrage refers to the process by which an individual can take advantage of the price differences that exist for an identical product across various markets by engaging in purchase and sales of the same.When the law of one price is violated there will be price differences for the same product across multiple markets.This can be exploited by individuals by buying from a market where the asset is priced less and selling in a market where the asset price is higher and thereby making a profit.This is how the violation of law of one price can lead to arbitrage opportunities.

jeff jeffy answered 2 years ago

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