11/19/12
Problem Set 4
Arbitrage
Warm-up: Problem 2
£ 500,000
$1,250,000
$1=£0.40
NY
$1,000,000
LON
£1=CHF 2.30
$1=CHF 1.15
ZUR
CHF 1,150,000
Profit = $250,000
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11/19/12
Problem 6
(Basis too big)
500,000 bu
$1,050,000
Money $2.00 per bushel
today
3%
Wheat
today
Storage 10¢
$1,065,649.08 Money
30
later $2. per bushel
Wheat
later
$1,150,000
500,000 bu
Profit = $84,350.92
Problem 7
Lend @ 18.45%
(Basis too small)
500,000 bu
$1,000,000
Money $2.00 per bushel
today
Wheat
today
3%
$1,014,903.88 Money
02
later $2. per bushel
$1,010,000
Profit = $4,903.88
Wheat
later
500,000 bu
Borrowing @ 2.02%
2
11/19/12
Problem 9
This is includes a Floating/Floating Swap
BW Homes
Net for RRNB: extra 1% each year
T + 2%
RRNB
LIBOR + 1%
LIBOR
CitiCorp
T-Bill + 1%
Counterparty
T-Bill
LIBOR + 1%
Midland Bank
$10,000 per year profit!
Problem 10
•  Breakup Value
$750,000,000 from Shug’s Restaurants
$600,000,000 from Betty’s Boutiques
$200,000,000 from airline liquidation
$1,550,000,000 Total
•  Market Value of Package: $1,000,000,000
•  Value of airline as going concern:
$550,000,000
3
11/19/12
Problem 11
C(S,X,t) + B(X,t) = S + P(S,X,t)
$9 + $89
$98
$95 + $2.50
$97.50
Profit = 50 cents
Problem 12
C(S,X,t) + B(X,t) = S + P(S,X,t)
$12 + $84.06
$96.06
$10 + $89
$99
Build a Box!
$95 + $1.25
$96.25
$95 + $1.75
$96.7
5
4
11/19/12
Problem 12
So, what comes from building the box?
Initially: $10 – $1.75 – $12 + $1.25 = – $2.50
At expiration you will receive $5 no matter what
$90 – $85 = $5
S
90
85
Double your money!
Problem 13
E(R)
CML
10%
8%
3%
5%
8%
σ
Phillips is below the market line
Need to know beta
5
11/19/12
Problem 14
E(R)
CML
12%
8%
3%
5%
σ
8%
ARCO is above the market line
This is an arbitrage opportunity!
Problem 15
E(R)
SML
25%
20%
15%
11%
5%
0.5
1.0
1.5
2.0
β
Stock B is undervalued
6
11/19/12
Problem 16
E(R)
SML
15%
13%
5%
0.8
1.0
β
This stock is on the market line
It is in equilibrium
Problem 21
•  Value of new package (per Value Additivity
Principle)
$100,000,000 for Megalithic Iron Works
$50,000,000 for Newton Brickyards
$150,000,000 Total
•  Less cash paid to Newton Stockholders:
$100,000,000
•  Remaining value of Megalithic stock:
$50,000,000
7