Reference no: EM13799159

1. Your friend tells you about an arbitrage opportunity. You can buy stock for $25 in Tokyo and sell it for $25.05 in New York. You judge the opportunity cost of lost interest to be mini-mal (no more than $10). Based on previous trading, you expect it will cost you $0.02 per share to buy in Tokyo and $0.02 per share to sell in New York. There are additional expenses of $0.03 per share for such things as transfer and communications costs. You will pay someone $26 to handle the transac-tions for you. How many shares must you sell to realize an "arbitrage" opportunity that will actually yield a riskless profit?

a. You cannot realize an arbitrage profit because variable costs are greater than the per share revenue from buying and selling shares.

b. To realize a riskless arbitrage you should plan on selling enough shares to overcome lost interest and handling costs.

c. To realize a riskless arbitrage you should plan on selling enough shares to cover all variable costs.

d. none of these

2. Your assets have an equal chance of being worth either $1,600 or $800 at year's end. Your debt is $1,000 and due at the end of the year. Now suppose you substitute your current assets for riskier assets that have the same expected value but a wider dispersion. The riskier assets now have equally likely payoffs of $1,800 and $600. What is the NPV of the asset substitution?