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Postby bhuyanpk » Wed Sep 02, 2015 4:36 pm

You believe the stock of Microsquish reflects a 90% chance of a dismissal of its contractual liability suit. If the suit is dismissed, you expect the stock of Microsquish and its partner, AWOL, to rise. If the suit is not dismissed, both will fall in price. However, you think that AWOL's stock only reflects a 60% chance of dismissal of this suit. What strategy would be optimal?
Choose one answer.
a. Sell both short
b. Buy Microsquish
c. Buy AWOL

Which category of probability this question belongs to? and how to approach them?


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Re: Quant-I

Postby edupristine » Thu Sep 03, 2015 11:09 am

The values 90% and 60% are not consistent. If the true probability of a lawsuit dismissal is only 60%, then AWOL's stock is fairly valued, and Microsquish is overvalued. If the true probability is 90%, then Microsquish is fairly valued, and AWOL is undervalued. You can thus construct a profitable riskfree strategy. You should buy AWOL, because at worst, the stock will be fairly valued. At best, it is undervalued.

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