Question

The stock of XYZ Corp. is trading for $100 on the New York Stock Exchange and $97 on the London Stock Exchange. Assume that the costs of buying and selling the stock on both exchanges are negligible.

a. What could you do to make a profit in this situation? What is this called? (2 pts)

b. As you keep doing what you’re doing to make a profit, what would you expect to happen to the price on the New York Stock Exchange and the price on the London Stock Exchange? (2 pts)

c. Now assume that the cost of buying and selling shares of XYZ Corp. is 4% per transaction. How does this affect your answer? (2 pts)

Answer 1

a. to have profit will buy the stock from the london stock exchange and sell it on new york stock exchange it is called the inter exchange arbitrage that means to gain from the different rates of stock on the different exchanges

b. if we keep doing this thing due to that the london stock exchange will have huge buying orders while the new york stock exchange will have huge selling and order whcih will result in to price rise in the stock in london stock exchange and the decrease in the stock price in the new york stock exchange and the arbitage opportunity will be nullified.

c. no if there is transaction cost the cost of stock at london stock exchange = 97*1.04 = $100.88

and sales proceed on newyork stock exchange will be equal = 100*0.96 = $96

so if enters into same transaction shown above hence we will have to bear the loss of $4.88 per share so such trasaction cost will nullified the inter exchange arbitrage opportunity.