There are two stocks and a risk-free bond (yielding 4% p.a.) in an economy. Stock AXE is currently trading at $50, and it will have a value of $75 ($40) one year from now if the economy turns out to be good (bad). Stock BYF is currently trading at $38, and its future values are $60 and $32 respectively for the good and bad states. Shorting is allowed, but borrowing at the risk-free rate is not possible. Is there an arbitrage opportunity? How to take advantage of it?

Answer rating: 100% (QA)

To determine if there is an arbitrage opportunity we need to compare the expected return from a risk... View the full answer