Suppose for simplicity that a stock market index such as the S&P 500 currently is at 1,000. Assume that an indexed portfolio on the index pays year end dividends of $20 on an investment of S1000. The risk-free interest rate is 1% and the actual futures price, FO = $1,010. By filling in the table below, show that an investor can make arbitrage profits of $20 by shorting the relatively overpriced futures contract and buying the relatively underpriced stock portfolio using money borrowed at the 1% market interest rate. Action Initial cash flow Cash Flow in 1 Year Borrow $1,000, repay with interest in 1 year Buy stock index for $1,000 Enter short futures position | (F0 = $1,010) %3D Total
Suppose for simplicity that a stock market index such as the S&P 500 currently is at 1,000. Assume that an indexed portfolio on the index pays year end dividends of $20 on an investment of S1000. The risk-free interest rate is 1% and the actual futures price, FO = $1,010. By filling in the table below, show that an investor can make arbitrage profits of $20 by shorting the relatively overpriced futures contract and buying the relatively underpriced stock portfolio using money borrowed at the 1% market interest rate. Action Initial cash flow Cash Flow in 1 Year Borrow $1,000, repay with interest in 1 year Buy stock index for $1,000 Enter short futures position | (F0 = $1,010) %3D Total
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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12.
Transcribed Image Text:Suppose for simplicity that a stock market index such as the S&P 500 currently is at
1,000. Assume that an indexed portfolio on the index pays year end dividends of $20
on an investment of S1000. The risk-free interest rate is 1% and the actual futures
price, FO = $1,010. By filling in the table below, show that an investor can make
arbitrage profits of $20 by shorting the relatively overpriced futures contract and
buying the relatively underpriced stock portfolio using money borrowed at the 1%
market interest rate.
Action
Initial cash flow
Cash Flow in 1 Year
Borrow $1,000, repay with
interest in 1 year
Buy stock index for $1,000
Enter short futures position
(FO = $1,010)
Total
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