Suppose there are three stocks A, B, and C. There are only two states of the world. In each of the two states, our three stocks have the following payoffs:
Stock Price (Payoff in State I) (Payoff in State II)
A 60 50 100
B 80 30 120
C 70 38 112
(a) Show that there exists an arbitrage opportunity between these stocks. (Try combining stocks A and B to make a portfolio that is identical to stock C in both states)
(b) Based on your answer in part (a), tell me the zero investment portfolio that would get you positive profit