introduction to arbitrage Flashcards
what is the law of one price
given that two assets have the same payoff for all future assets, to preclude arbitrage both assets must have the same price in the present
what is an option
an option is a purchased right to do something (call, put) without the obligation to do it
purchasing a call option is the right to buy an asset at a strike (agreed upon) price
purchasing a put option is the right to sell an asset at a strike (agreed upon) price
what is a zero-coupon bond?
an asset that pays the profit only at maturity i.e. no interest payments throughout (hence, “zero)
define the put-call parity. for it to hold, what are the necessary assumptions?
states that for there to be no arbitrage opportunity, holding a put option would give you the same profit as a call option, both for the same underlying asset class
they must expire at the same time period, and both options must have the same strike price
what are the main criteria for a preference relation to be considered rational?
in other words, what are the axioms of preference relations?
- preference relations are rational
completeness: all bundles within the consumption set should have a preference relation w.r.t. any other bundle
transitive: for x,y,z in a specific consumption set, if x>y, y>z, then x>z
- preference relations are continuous
the relation is preserved under limits
when is a utility function representative of a preference relation?
if x is weakly preferred to y, then the utility function where u:consumption set -> R represents the preference if and only if u(x) >= u(y)
why is learning preference relations important? i.e. why is understanding what a strict preference is, what is indifference in terms of weak preference, what is strict preference in terms of weak preference
preference relations are applied to the different measures of dominance
