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IAI Actuarial Core Principles · Business Finance · Key principles of finance

A share is quoted at ₹500 on the NSE and at ₹503 on the BSE at the same moment. Ignoring transaction costs, what would the trading of arbitrageurs be expected to cause?

Arbitrageurs would buy on the NSE at ₹500 and sell on the BSE at ₹503, pushing the NSE price up and the BSE price down until the two prices converge and the riskless profit disappears.

  1. AThe NSE price to rise and the BSE price to fall until the prices convergeCorrect
  2. BBoth prices to rise because of increased trading volume
  3. CThe NSE price to fall and the BSE price to rise
  4. DNo change, since exchanges are separate markets
  5. The BSE price to rise further as demand there is stronger

Explanation

Arbitrageurs buy on the cheaper exchange (NSE) and sell on the dearer one (BSE). Buying pushes the NSE price up and selling pushes the BSE price down, so the gap closes. The opposite direction (option 2) would widen the gap.

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