Answer:
a) Cash-and-carry-arbitrage would be used
b) reverse cash and carry arbitrage would be used
Explanation:
a. Suppose you observe a 6-month forward price of 1120
Given that:
Spot price ([tex]S_0[/tex]) = 1100
Time (T) = 6 months = 6/12 years = 0.5 year
Risk free rate (r) = 5% = 0.05
Divided (d) = 2% = 0.02
observed forward price = 1120
The fair forward price ([tex]F_{0,T}[/tex]) is given as:
[tex]F_{0,T}=S_0e^{(r-d)T}=1100 * e^{(0.05-0..02)0.5}=1116.62[/tex]
Therefore the forward price of 1120 is expensive, creating a long forward of 3.38
b. Suppose you observe a 6-month forward price of 1110. What arbitrage would you undertake
Given that:
Spot price ([tex]S_0[/tex]) = 1100
Time (T) = 6 months = 6/12 years = 0.5 year
Risk free rate (r) = 5% = 0.05
Divided (d) = 2% = 0.02
observed forward price = 1110
The fair forward price ([tex]F_{0,T}[/tex]) is given as:
[tex]F_{0,T}=S_0e^{(r-d)T}=1100 * e^{(0.05-0..02)0.5}=1116.62[/tex]
Therefore the forward price of 1120 is expensive, creating a short forward of 6.62, reverse cash and carry arbitrage would be used
