The Mechanism
Mechanism:
Have stakeholder A who produces a product/good for x = $1.40
Stakeholder A supplies product/good to market 1 and the equilibrium price in market 1 is y = $1.50
The profit stakeholder A receives is equal to y - x (1.50 - 1.40 = 0.10)
Stakeholder B sells product/good to stakeholder C with the market price in market 2 being $1.60. The initial price in Market 2 is equal to z = y + (y - x)
At a given time in the future, stakeholder C will receive z - y back from stakeholder A ( z - y = y - x). Stakeholder C essentially loans z - y to stakeholder A and the interest they receive will be decided by the market.
The profit = z - y will be split between stakeholders A and B.
The equilibrium price of the product/good in market 1 should rise due to the arbitrage opportunity between market 1 and market 2. However, the equilibrium price in market 2 should increase as when the equilibrium price in market once rises, stakeholder C could simply sell the product/good in market 1 then wait until the future date at which time they will receive z - y.
Summary of mechanism:
Stakeholder A will supply their product/good to Market 1. The equilibrium price in Market 1 is equal to y and stakeholder A will sell their product to stakeholder B at the market equilibrium price and receive a profit equal to y - x. An arbitrage opportunity exists between Market 1 and Market 2. Stakeholder B will buy product/good in Market 1 and sell the product/good in Market 2 to stakeholder C. Stakeholder C would purchase the product/good for z = y + (y - x). The profit, which is equal to z - y will be split between stakeholder A and stakeholder B. In addition, stakeholder C is essentially loaning z - y to stakeholder A as at a given time in the future, z - y will be returned to stakeholder C.
Have two arbitrage opportunities; firstly the product bought in market 1 and sold in market 2 and the product (composed of good/product and money lent to stakeholder A) sold in market 2.
Due to the arbitrage between Market 1 and Market 2; one can purchase product/good in Market 1 then sell in Market 2 and receive risk free profit equal to a portion of y - x. The second arbitrage opportunity is the security traded in market 2. The security is composed of ownership of the product/good and essentially a bond as owner will receive z - y at a given time in the future. As a result of the bond, stakeholder C is essentially purchasing the good/product at the same price as stokehold B.
As time progresses, the market price in Market 1 (y) should increase. This should result in an increase in equilibrium price in Market 2 (z) as one could sell the product/good in Market 1 then wait to receive the money lent to stakeholder A (z - y) thus the value of the security in Market 2 is equal to y + (y - x). As y increases, z should also increase otherwise will have arbitrage opportunity however y should also increase towards z to counter the first arbitrage opportunity.
Example:
Have stakeholder A who produces a product/good for x = $1.40
Stakeholder A supplies product/good to market 1 and the equilibrium price in market 1 is $1.50.
The profit stakeholder A receives is equal to y - x (1.50 - 1.40 = 0.10)
Stakeholder B sells product/good to stakeholder C with the market price in market 2 being $1.60. The initial price in Market 2 is equal to y + (y - x)
Stakeholder C essentially loans z - y to stakeholder A and the interest they receive will be decided by the market.
Due to arbitrage present between Market 1 and 2, the demand in Market 1 will increase resulting in an increase in equilibrium price.
If price rises to $1.52, then can still purchase product/good from Market 1 and sell in Market 2. However, also consider that stakeholder C will then sell their product in Market 1 thus receiving $1.52, however they paid $1.60. However at a given time in the future, will receive $0.10 from stakeholder A. Thus at a given time in the future, will have a total of $1.62 thus making a risk free profit of $0.02. Thus the value of the security owned by stakeholder C will rise from $1.60 to $1.62 in market 2 when the price increases from $1.50 to $1.52 in market 1.
If stakeholder C does not sell their security and holds it until they receive the funds they loaned to stakeholder A (z - y), they can then become stakeholder A in which they sell product/good in Market 1 and loan money from a new stakeholder C.
Three themes:
Arbitrage, infinity, wrong