medium · FRM Part 1 Valuation and Risk Models
According to the Law of One Price, if two portfolios produce identical cash flows in all future states of the world, they must have the same current price.
If they do not, what is the resulting opportunity?
- A speculative opportunity, where an investor bets on which portfolio will perform better in the future.
- A diversification benefit, as the two portfolios likely have low correlation.
- A hedging opportunity, where one portfolio is used to offset the risk of the other.
- An arbitrage opportunity, where an investor can buy the cheaper portfolio and sell the more expensive one for a riskless profit.
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