Two firms are identical, except that firm "A" is totally financed with equity and the "firm B" is financed with 50% of equity and 50% of debt. There are no corporate taxes, no bankruptcy costs, and no transaction costs. The market value of equity of firm A is € 1000. The market value of equity and debt of firm B is € 600 and € 600 respectively. Both firms will be liquidated in one year generating exactly the same unknown cash flow X. 

Describe the arbitrage strategy that could be implemented in this situation and Explain how it will affect market prices.

Answer rating: 100% (QA)

In this situation an investor could implement an arbitrage strategy to take advantage of the differe... View the full answer