What Steps Would You Follow in Order to Take Advantage

question 7

Essay

What steps would you follow in order to take advantage of the following arbitrage opportunity (if there is one)? Security A costs $100 and pays $120 in 3 years. Security B costs $100 and pays $110 in one year. Your friend tells you that he would like you to lend him $110 in a year and that he would give $130 the following year. Finally you know that in two years, with $130, you can invest in a security that will pay you either $140 or $121 (with equal probability) after a year. 2

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Definitions:

Marginal Utility

The augmented satisfaction or value someone derives from the consumption of an extra unit of a good or service.

Consumer Surplus

Consumer surplus represents the discrepancy between the total price consumers are prepared and able to spend on a product or service and the actual amount they end up paying.

Marginal Utility

The additional satisfaction or utility a consumer receives from consuming one more unit of a good or service.

Marginal Utility

Marginal utility represents the additional satisfaction or utility a consumer gains from consuming one more unit of a good or service.