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Oksanka [162]
3 years ago
13

Suppose that the risk-free interest rate is 10% per annum with continuous compounding and that the dividend yield on a stock ind

ex is 3% per annum. The index is standing at 395, and the futures price for a contract deliverable in three months is 404.
What arbitrage opportunities does this create?
Business
1 answer:
Tasya [4]3 years ago
4 0

Answer:

See Below

Explanation:

We can use the future price formula here, which is:

F=Pe^{(r_f-d_y)*\frac{n}{12}}

Where

F is the theoretical future price

P is the present index standing

r_f is the risk free rate

d_y is the dividend yield

n is the number of months of the futures deliverable

Now,

given

P = 395

r_f = 0.1

d_y = 0.03

n = 3

Substituting, we get:

F=Pe^{(r_f-d_y)*\frac{n}{12}}\\F=(395)e^{(0.1-0.03)*\frac{3}{12}}\\F=(395)e^{0.0175}\\F=401.97

Actual future price is 404. The index future price is higher. So the strategy would be to sell the futures contracts. Long the shares underlying the index.

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