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

The law of one price most likely implies that two assets with identical future cash flows in all states of the world:

Assets with identical payoffs in every state must sell for the same price, ignoring transaction costs. If prices differed, an investor could buy the cheaper one and sell the dearer one for a riskless profit, and trading would push prices back together.

  1. Amust have identical prices, apart from transaction costsCorrect
  2. Bmust have prices that differ by their risk premiums
  3. Cmust have identical expected returns but may have different prices

Explanation

If two assets have identical payoffs in every state, they must trade at the same price, otherwise buying the cheaper and selling the dearer earns an arbitrage profit. Since payoffs are identical, there is no risk premium difference to justify a price gap.

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