tutorial2sol - TUTORIAL 2 WEEK 3 ECON3107/ECON5106...

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Unformatted text preview: TUTORIAL 2 WEEK 3 ECON3107/ECON5106 Economics of Finance ANSWERS 1 . Consider the following trades. First, trade 1PA for 1 . 3 GA. Then, trade the obtained amount of GA for BA. These trades can be summarized as 1 PA- 1 . 3 GA- 1 . 3 . 6 BA = 2 BA. Hence 1BA costs 0.5PA. 2 . One way to determine whether there are arbitrage opportunities is the following. Consider the impact of trading in a clockwise and anticlockwise direction: Clockwise : 1 PA- 1 . 3 GA- 2 BA- 1 . 2 PA This trading sequence generates a profit of 0.2PA. Hence, there are arbitrage opportunities if you trade in the clockwise direction. Anticlockwise : 1 PA- 1 . 6 BA- 1 (0 . 6) 2 GA- . 3 (0 . 6) 2 PA = 5 6 PA If you trade in the anticlockwise direction, you will make a loss. Also, note that if you trade in one direction followed by the other direction you must break even, i.e., 1 . 2 5 / 6 = 1 (when there are no transaction costs)....
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tutorial2sol - TUTORIAL 2 WEEK 3 ECON3107/ECON5106...

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