##### Reference no: EM132012829

Suppose initially that two assets, A and B, will each make a single guaranteed payment of $400 in one year. But asset A has a current price of $300 while asset B has a current price of $340.

Instructions: Round your answers to 2 decimal places.

a. 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 and sell asset .

b. 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? . Next, consider another pair of assets, C and D. Asset C will make a single payment of $600 in one year, while D will make a single payment of $800 in one year. Assume that the current price of C is $460 and that the current price of D is $700.

c. 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 and sell asset .

d. 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? . Compare your answers to questions a through d before answering question e.

e. We know that arbitrage will equalize rates of return. Does it also guarantee to equalize prices? . In what situations will it also equalize prices? .