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Correct answer is A, E, H. Please explain how to solve. 1. Assume markets are perfect as described in Chapter 17. Firm U and Firm
Correct answer is A, E, H. Please explain how to solve. 1. 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 U's equity is $5000. Firm L has risk-free perpetual debt with a market value of $3000 and equity with a market value of $3000. Therefore, the market values of Firm U and Firm L are $5000 and $6000 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 $600 of Firm L equity C. Sell short $500 of Firm U equity Pick one G. Invest $500 into the equity of Firm U H. Invest $600 into the equity of Firm U 1. Invest $500 into the equity of Firm L J. Invest $600 into the equity of Firm L Pick one D. Borrow $500 E. Borrow $300 F. Borrow $600
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