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Suppose there are three stocks A, B, and C. There are only two states of the world. In each of the two states, our three
Suppose there are three stocks A, B, and C. There are only two states of the world. In each of the two states, our three stocks have the following payoffs:
Stock Price (Payoff in State I) (Payoff in State II)
A 60 50 100
B 80 30 120
C 70 38 112
(a) Show that there exists an arbitrage opportunity between these stocks. (Try combining stocks A and B to make a portfolio that is identical to stock C in both states)
(b) Based on your answer in part (a), tell me the zero investment portfolio that would get you positive profit
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