Assume that Arthur Corp. and Dutch Inc. have identical assets that will pay off either $400 million, $500 million or $750 million a year from today. Arthur is funded with bonds that mature for $300 million one year from today and with equity, but Dutch is funded with bonds that mature for $450 million one year from today and with equity. The market value of Arthur bonds is $275 million and of its equity is $225 million, and the market value of Dutch bonds is $415 million and of its equity is $80 million. If markets are perfect, what set of transactions today will generate an arbitrage profit for you? Show that the conditions of arbitrage are met regardless of whether the firms’ assets end up begin worth $400 million, $500 million or $750 million. Notes: 1) calculations required, 2) use “+” for inflows and “–” for outflows.

Answer rating: 100% (QA)

Formulas Used w N A B C D 1 Payoffs 2 4001 3 500 4 750 5 6 Expected Payoff 550 7 8 Parti... View the full answer