Question

In: Accounting

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

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.


$8

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