The following table shows prices of three shares that would prevail under three economic scenarios.

stock A B C

Recession A=12,B=8,C=9

Normal A=7,B=13,C=9

BOOM A=15,B=5,C=9

If all of these stocks cost $8 today. Perform necessary calculations to check if there are any arbitrage opportunities.

Solutions

Expert Solution

There is an arbitrage opportunity if you can buy a stock for less than its intrinsic value and sell it for more.

For example, in the recession scenario, Stock A is selling for $12, but its intrinsic value is $7.

This means that you can buy Stock A for $12 and sell it immediately for $7, resulting in a profit of $5.In the BOOM scenario, Stock B is selling for $5, but its intrinsic value is $13. This means that you can buy Stock B for $5 and sell it immediately for $13, resulting in a profit of $8.

Junaid answered 1 year ago

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