Assume markets are perfect as described in Chapter 17. Firm U and Firm L have the exact same assets (managed in exactly the same way). Firm U has no debt. The market value of Firm Us equity is $7500. Firm L has risk-free perpetual debt with a market value of $3000 and equity with a market value of $5000. Therefore, the market values of Firm U and Firm L are $7500 and $8000 respectively. Since these two firms do not have the same market value, you should be able to earn a true arbitrage. What are the three positions you need to take at time zero to earn a true arbitrage profit? (Use the procedures we discussed in class. Also, as in class, assume alpha = 10%. You must get all three answers correct to get credit.)

Pick one

A. Sell short $300 of Firm L equity

B. Sell short $500 of Firm L equity

C. Sell short $750 of Firm U equity

Enter the letter (A, B, or C) for the correct answer in the box here: [X]

Pick one

D. Invest $500 into the debt of Firm L

E. Invest $300 into the debt of Firm L

F. Borrow $300 Enter the letter (D, E, or F) for the correct answer in the box here: [Y]

Pick one

G. Invest $800 into the equity of Firm U

H. Invest $750 into the equity of Firm U

I. Invest $400 into the equity of Firm L J. Invest $500 into the equity of Firm L

Enter the letter (G, H, I, or J) for the correct answer in the box here: [Z]