ARBITRAGE IN OUR CASE Assume that the interest rates for 2 years out are flat at 9%. If the one-year futures is trading in the market for $9,500, what will you do? If the one-year future is $9,500 there is an arbitrage opportunity since the assed is undervalued according to our previous calculations which price the one-year future at $10,600. To take advantage of these mispriced futures we must buy the one-year future contract that's $9,500 and short sell the index future for $10,000. You will invest the $10,000 you gain from the short sale at 9%. You will have $10,900 by the end of the year, and you will have to buy the $9,500 future contract. 7 Value of arbitrage= $10,900 (from investment)- $9,500 (future)= $1,400 after 1 year ARBITRAGE OPPORTUNITY $12,000 $10,000 $8,000 $6,000 $4,000 $2,000 $9,500 Arbitrage Opportunity $10,900 || $1,400 one year futurespri Value of interest arbitrage profit ARBITRAGE OPPORTUNITY Today: Short sell index ❘ at $10,000 Buy futures contract ❘ at $9,500 Invest proceeds | $10,000@ After 1 Year: | Investment natures | Futures contract matures | Buy index ❘ to $10,900 ❘ at $9,500 ❘ at $9,500 Profit $1,400
ARBITRAGE IN OUR CASE Assume that the interest rates for 2 years out are flat at 9%. If the one-year futures is trading in the market for $9,500, what will you do? If the one-year future is $9,500 there is an arbitrage opportunity since the assed is undervalued according to our previous calculations which price the one-year future at $10,600. To take advantage of these mispriced futures we must buy the one-year future contract that's $9,500 and short sell the index future for $10,000. You will invest the $10,000 you gain from the short sale at 9%. You will have $10,900 by the end of the year, and you will have to buy the $9,500 future contract. 7 Value of arbitrage= $10,900 (from investment)- $9,500 (future)= $1,400 after 1 year ARBITRAGE OPPORTUNITY $12,000 $10,000 $8,000 $6,000 $4,000 $2,000 $9,500 Arbitrage Opportunity $10,900 || $1,400 one year futurespri Value of interest arbitrage profit ARBITRAGE OPPORTUNITY Today: Short sell index ❘ at $10,000 Buy futures contract ❘ at $9,500 Invest proceeds | $10,000@ After 1 Year: | Investment natures | Futures contract matures | Buy index ❘ to $10,900 ❘ at $9,500 ❘ at $9,500 Profit $1,400
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
Related questions
Question
Please give me the correction calculation and include all the necessary calculations for the solution to make sure so there is no confusion and construct graphs
Transcribed Image Text:ARBITRAGE IN OUR CASE
Assume that the interest
rates for 2 years out are flat
at 9%. If the one-year
futures is trading in the
market for $9,500, what will
you do?
If the one-year future is $9,500 there is an arbitrage
opportunity since the assed is undervalued according to
our previous calculations which price the one-year future
at $10,600.
To take advantage of these mispriced futures we must buy the
one-year future contract that's $9,500 and short sell the index
future for $10,000. You will invest the $10,000 you gain from the
short sale at 9%. You will have $10,900 by the end of the year,
and you will have to buy the $9,500 future contract.
7
Value of arbitrage= $10,900 (from investment)- $9,500
(future)= $1,400 after 1 year
ARBITRAGE OPPORTUNITY
$12,000
$10,000
$8,000
$6,000
$4,000
$2,000
$9,500
Arbitrage Opportunity
$10,900
||
$1,400
one year futurespri
Value of interest
arbitrage profit
ARBITRAGE OPPORTUNITY
Today:
Short sell index
❘ at $10,000
Buy futures contract
❘ at $9,500
Invest proceeds |
$10,000@
After 1 Year:
| Investment natures
| Futures contract matures |
Buy index
❘ to $10,900
❘ at $9,500
❘ at $9,500
Profit
$1,400
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