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:

Product Costs

Costs directly associated with the production of goods or services, including direct materials, direct labor, and manufacturing overhead.

Current Profits

The earnings a company has generated during a particular period, not taking into account future liabilities or investments.

Variable Costing

A costing method that includes only variable production costs (materials, labor, and overhead) in product costs, excluding fixed overhead expenses.

Cost Per Unit

The calculation of the total cost of producing a product or providing a service divided by the number of units produced or serviced.