TranscribedText: Question 2: Consider the simple no-arbitrage arguments given in the first class (a single cash flow of $100, interest rate of 4.17%, simple compounding, etc.). Suppose that the asset is undervalued, trading at $95 instead of $96. We went through a number of examples to generate cash flows of different amounts at different times, in the example below, we received $1 today. % Example 1: Price too low Trade Next period Borrow money -$100 Buy Asset [ +$100 Net Cash Flow $0 * A pure arbitrage: trade generates a profit today with no risk (no obligation in the future). 1. Can you create a trading strategy that generates $100 today with no exposure next period? 2. Can you create a trading strategy that generates $100 next period with no exposure today? 3. Canyou create a trading strategy that generates positive cash flow in both periods

Question 2: Consider the simple no-arbitrage arguments given in the first class (a single cash flow of $100, interest rate of 4.17%, simple compounding, etc.). Suppose that the asset is undervalued, trading at $95 instead of $96. We went through a number of examples to generate cash flows of different amounts at different times, in the example below, we received $1 today. Example 1: Price too low Trade Today Next period Borrow money +$96 -$100 Buy Asset -$95 +$100 Net Cash Flow +$1 $0 A pure arbitrage: trade generates a profit today with no risk (no obligation in the future). 5/25/2018 39