Strategy for the acceptance of low returns in the shorter run for capturing the market platform cannot be considered as sustainable as time passes by. This is because the environment of high risk investment will hold a corresponding requirement for high expected return. In the long term, information flow across the market platform regarding the profile of projects in risk that will assist to obtain increased rational risk pricing. Rational pricing assumes that asset prices provide reflection of arbitrage free price related to the asset while deviating from the arbitrage of price. This particular assumption is crucial to price securities of fixed income, specifically bond, which can be considered fundamental to price derivative instruments. As a result, there is significant deviation of prices out of fundamental values because of the existing irrational investors (Hofstede, 2011).
Arbitrage can be considered as the practice to take advantage of a specific condition of imbalance among two or more market platforms. On the exploitation of this mismatch, such as after dividends, transport costs, storage costs and transaction costs, the arbitrageur will be locking in a profit free of risk by selling and purchasing across both market platforms simultaneously. Rational pricing is a significant approach utilized in pricing the bonds at fixed rate. This category of investment tends to be enabling extra returns, while providing accessibility of diversification advantages.
Rational risk pricing considers factors like the credit score of consumer, adverse history of credit, employment income and status, being highly dependent upon the category of loan. The companies utilizing rational risk pricing include telecommunications businesses, utility companies, mortgage lenders and credit card issuers (Jeong et al., 2009). Other companies will be considering the credit score of consumer prior to agreement of doing business with the respective stakeholders.