EBK INVESTMENTS
11th Edition
ISBN: 9781259357480
Author: Bodie
Publisher: MCGRAW HILL BOOK COMPANY
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Chapter 22, Problem 16PS
Summary Introduction
To compute: The arbitrage strategy required to exploit the mispricing in future market. Supposing that S&P futures price for delivery in 1 year is 2,050, current value is 2,000, T-bill rate is 4%.
Introduction:
Arbitrage: Arbitrage can be termed as that transaction done through which there is a chance of two assets producing the same results but may sell at different prices. Arbitrage is important due to the fact the when there is a huge purchase of assets which are cheaper, its price will increase. On the other hand, when an asset is sold at a high price, its price will decrease.
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The S&P portfolio pays a dividend yield of 1% annually. Its current value is 1,300. The T-billrate is 4%. Suppose the S&P futures price for delivery in 1 year is 1,330. Construct an arbitragestrategy to exploit the mispricing and show that your profits 1 year hence will equal the mispricing in the futures market.
A European call that will expire in one year is currently trading for $3. Assume the risk-free rate (based on continuous compounding) is 5%, the underlying stock price is $60 and the strike price is $55.
a. Is there an arbitrage opportunity?
b. Describe exactly what a trader should do to take advantage of the arbitrage opportunity assuming it exists.
c. Determine the present value of the profit that the trader can earn assuming you identify an arbitrage opportunity.
Use at least four decimal places for those questions that require a numerical answer.
The S&P500 index is currently valued at 2862. What should be the price (FO) on the futures contract
expiring 79 DAYS from now if the S&P500 has a dividend yield of 1.70%, the rf is 2.75%, and the
S&P500 has an expected return of 5.00%?
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O 2,852.85
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