Security A costs $94 and pays $100 in one year. Security B costs $85 and pays $100 in two years. Both payments are certain. Assume frictionless trading and short selling.
One unit of each security reproduces both cash flows.
Buy the underpriced security and short half a unit of A plus one unit of B. Receive $2 today; future payments exactly cancel.
| Position | Today | Year 1 | Year 2 |
|---|---|---|---|
| Buy security | −130 | +50 | +100 |
| Short ½ A | +47 | −50 | 0 |
| Short B | +85 | 0 | −100 |
| Net | +2 | 0 | 0 |
One ETF unit represents two HP shares, one Sears share and three Ford shares. Their respective prices are $28, $40 and $14. Assume the basket can be replicated and traded without fees or restrictions.
Buy one ETF unit and short its basket. The initial profit is $138 − $120 = $18. The underlying economic exposures offset.
Short one ETF unit and buy the basket for $138. The initial profit is $12. In practice, fees, short-sale constraints and creation/redemption access must be considered.