Suppose initially that two assets, A and B, will each make a single guaranteed p
ID: 1215303 • Letter: S
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%
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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.