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ARBITRAGE IN OUR CASE 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. 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? 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. Value of arbitrage= $10,900 (from investment)- $9,500 (future)- dividends owed (3% of $10,000)= $1,100 after 1 year Today: | Short sell index | ❘ at $10,000 | Buy futures contract | | at $9,500 | Invest proceeds | I | $10,000 @ 9% | After 1 Year: | Investment matures | | to $10,900 | Futures contract matures | ❘ at $9,500 | Buy index | ❘ at $9,500 | Profit | | $1,400

ARBITRAGE IN OUR CASE 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. 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? 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. Value of arbitrage= $10,900 (from investment)- $9,500 (future)- dividends owed (3% of $10,000)= $1,100 after 1 year Today: | Short sell index | ❘ at $10,000 | Buy futures contract | | at $9,500 | Invest proceeds | I | $10,000 @ 9% | After 1 Year: | Investment matures | | to $10,900 | Futures contract matures | ❘ at $9,500 | Buy index | ❘ at $9,500 | Profit | | $1,400

Essentials Of Investments
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
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Fix the picture quickly by just adding the dividend owed into the calculation and changing the arbitrage profit to $1,100
ARBITRAGE IN OUR CASE 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. 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? 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. Value of arbitrage= $10,900 (from investment)- $9,500 (future)- dividends owed (3% of $10,000)= $1,100 after 1 year
Transcribed Image Text:ARBITRAGE IN OUR CASE 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. 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? 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. Value of arbitrage= $10,900 (from investment)- $9,500 (future)- dividends owed (3% of $10,000)= $1,100 after 1 year
Today: | Short sell index | ❘ at $10,000 | Buy futures contract | | at $9,500 | Invest proceeds | I | $10,000 @ 9% | After 1 Year: | Investment matures | | to $10,900 | Futures contract matures | ❘ at $9,500 | Buy index | ❘ at $9,500 | Profit | | $1,400
Transcribed Image Text:Today: | Short sell index | ❘ at $10,000 | Buy futures contract | | at $9,500 | Invest proceeds | I | $10,000 @ 9% | After 1 Year: | Investment matures | | to $10,900 | Futures contract matures | ❘ at $9,500 | Buy index | ❘ at $9,500 | Profit | | $1,400
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