Suppose initially that two assets, A and B$,$ will each make a single guaranteed payment of $$400$ in $1$ year. But asset A has a current price of $$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

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and sell asset

$($Click to select$)$

$.$

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?

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Next, consider another pair of assets, C and D$.$ Asset C will make a single payment of $$600$ in $1$ year, while D will make a single payment of $$800$ in $1$ 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

$($Click to select$)$

and sell asset

$($Click to select$)$

$.$

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?

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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?

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In what situations will it also equalize prices?

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