Arbitrage is based on the idea that ________.
A) assets with identical risks must have the same expected rate of return
B) securities with similar risk should sell at different prices
C) the expected returns from equally risky assets are different
D) markets are perfectly efficient

Question

Quizplus · Accepted Answer

Arbitrage is the process of exploiting differences in the price of an asset in different markets to make a profit with no net cash flow. This idea is based on the principle that assets with identical risks must have the same expected rate of return. If there is any difference in expected returns, investors could buy the asset with the lower expected return and sell short the asset with the higher expected return. This would lead to an arbitrage opportunity, which would ultimately remove the price differential and restore equilibrium to the market.

Arbitrage Is Based on the Idea That ________