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Author Question: A popular value-weighted index is constructed out of shares in the two companies, shown in the table ... (Read 70 times)

tth

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on: Jul 10, 2018
A popular value-weighted index is constructed out of shares in the two companies, shown in the table below. On Day 1 you construct a portfolio that mimics the index with 15 invested in Company 1 and 85 invested in Company 2.
 
  On Day 2, what trades do you need to make in order to adjust your portfolio weights so that your portfolio earns the same return as the index from Day 2 to Day 3?
 
   Company 1 Company 1 Company 2 Company 2
  Day Price  of Shares Outstanding Price  of Shares Outstanding
  1 6.62 400 10.00 1,500
  2 7.53 400 10.54 1,500
  3 8.82 400 11.07 1,500
 
  A) Buy more of Company 1 and buy more of Company 2
  B) Buy more of Company 1 and sell some of Company 2
  C) Sell some of Company 1 and sell some of Company 2
  D) Sell some of Company 1 and buy more of Company 2
  E) Make no trades

Question 2

What does the law of one price say?
 
  What will be an ideal response?


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bassamabas

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Reply #1 on: Jul 10, 2018
Answer to Question 1

E

Answer to Question 2

Applied to international trade, the law of one price states that the same goods should sell for the same price in different
countries after making adjustment for the exchange rate between the two currencies. The idea is that the worth of a
good does not depend on where it is bought or sold. Thus, in the long run, exchange rates should adjust so that the
purchasing power of each currency is the same. As a result, exchange rates should reflect the international differences
in inflation rates, with countries with high rates of inflation experiencing declines in the value of their currency.
The law of one price is the underlying principle of the theory of purchasing-power parity (PPP) that states that
exchange rates adjust so that identical goods cost the same amount regardless of where in the world they are
purchased.


tth

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Reply #2 on: Jul 10, 2018
Thank you :)


bassamabas

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Reply #3 on: Jul 10, 2018
Happy to help you


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