Question

Discuss your understanding of risk-return and capital structure to the Law of One Price. Provide examples.

Answer 1

The law of one price states that a particular security should be available at the same price irrespective of the location where that particular security is traded or irrespective of the currency exchange rate

For example: You buy a international stock listed on the New York stock exchange and the London Stock exchange, both of them should be at the same price irrespective of the exchange rate between the dollar and pound. Also if you bought a stock with a higher beta in US, its risk should be at the same level on the London stock exchange. Lets says ABC Inc has a stock at $50 in US and 40 pounds in London, then the implied exchange rate is 1 Pound = 1.25 USD. Irrespective of the spot exchange rate this should be proved right on the long run.