Question

Arbitrage prevents:

Select one:

a. profit higher than the risk-free rate of return.

b. market efficiency.

c. two assets with identical payoffs from selling at different prices.

Answer 1

The Correct answer is C "Two Assets with identical payoffs from selling at diferent prices"

Arbitrage refers to Buying and selling of securities at different prices to take the advantage of difference of prices of the same securities.

If there will be a difference in price of securities of identical payoffs then the investor will take the opportunity to gain the risk free profit by buying and selling both sides. They will try to buy at low price and will sell at high price. Thus, Option C stands correct.

Arbitrage doesn't prevent market efficiency rather it makes the market more efficient. It tries to reduce limit the difference in prices of securities by taking advantage of it in case the opportunity arises.

The arbitage helps to gain the only the risk free profit that is the difference in price of security with same identical payoffs. So, the first option stands incorrect.