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CFA Level I · CFA Level I Exam · Arbitrage, Replication, and the Cost of Carry in Pricing Derivatives

A stock trades at 50.00 on Exchange X and 50.60 on Exchange Y at the same moment. Both trade in the same currency and can be settled immediately. Ignoring costs, an arbitrageur would most likely:

The arbitrageur buys on Exchange X at 50.00 and sells on Exchange Y at 50.60, locking in 0.60 per share riskless. The buying pressure raises X's price and the selling pressure lowers Y's price, so the two prices converge.

  1. Abuy on Exchange Y and sell on Exchange X, narrowing the price gap
  2. Bbuy on Exchange X and sell on Exchange Y, narrowing the price gapCorrect
  3. Cbuy on both exchanges, raising both prices until they converge

Explanation

Buy at the lower price (X) and sell at the higher price (Y), locking in 0.60 per share. Buying on X lifts its price and selling on Y depresses its price, so the gap narrows. Option A reverses the trade and would lose 0.60.

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