First you must pay your broker a commission on the

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Unformatted text preview: en you trade securities in markets such as the TSX, NYSE, and NASDAQ, you must pay two types of transactions costs. First, you must pay your broker a commission on the trade. Second, because you will generally pay a slightly higher price when you buy a security (the ask price) than you will receive when you sell (the bid price) it, you will also pay the bid-ask spread. For example, a share of Research In Motion stock (ticker symbol RIM) might be quoted as follows: Bid: $49.80 Ask: $49.90 We can interpret these quotes as if the competitive price for RIM were $49.85, but there is a transaction cost of $0.05 per share when buying or selling. What consequence do these transaction costs have for no-arbitrage prices and the Law of One Price? Earlier we stated that the price of gold in New York and London must be identical in competitive markets. Suppose, however, that total transactions costs of $5 per ounce are associated with buying gold in one market and selling it in the other. Then, if the price of gold is $1326 per ounce in New York and $1330 per ounce in London, the “Buy low, sell high” strategy no longer works: Cost: $1326 per ounce (buy gold in New York) (transactions costs) Indeed, there is...
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