490_lecture2_2011 - Lecture 2 Arbitrage Rate of Return...

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Lecture 2 Comments on Short Sales Arbitrage Rate of Return Importance of Compounding Predictability of Stock Returns Chapter 3 of Textbook Distribution of Returns Short Sales: More Details A does not hold shares of XYZ but wants to sell 100 shares to B. Regular Short: A’s broker borrows stock from costumer C and gives them to B. Naked Short: A’s broker does not borrow shares from anyone, i.e., B gets no actual shares delivered to his/her brokerage account. Security Lending Some companies do security lending (to facilitate shorts) as a business, e.g., AIG did it. AIG received money and collateral for this service. Unfortunately, they invested most of this in mortgage backed securities .... Arbitrage Suppose that following trades are possible: You can buy Dollars for ! 0.8 per Dollar. You can buy Pounds for US$1.6 per Pound. You can buy Euros for £0.7 per Euro. Can you find an easy way to make money?
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Example Arbitrage Suppose ADRs of Sanofi-Aventis SNY cost $40.00. 1 ADR corresponds to 1/2 share at the Euronext costs ! 60.00. What must the exchange rate be such that there is no arbitrage?
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