Suppose that the spot price of gold is US$1,700 per ounce. The quoted 1-year forward price of gold in the market is US$1,800, whereas it should have been $1,785. The 1-year US$ interest rate is 5% per annum. On the basis of the given information, answer the following: a) Is there an arbitrage opportunity? Why? b) If there is an arbitrage opportunity, show how will you exploit it? What will be the arbitrage profit? Hint: Recall that arbitrage means exploiting mispricing in the market to your advantage and any profit thus gained is risk-free. Use this understanding to formulate a response to this question.

Suppose that the spot price of gold is US$1,700 per ounce. The quoted 1-year forward price of gold in the market is US$1,800, whereas it should have been $1,785. The 1-year US$ interest rate is 5% per annum. On the basis of the given information, answer the following: a) Is there an arbitrage opportunity? Why? b) If there is an arbitrage opportunity, show how will you exploit it? What will be the arbitrage profit? Hint: Recall that arbitrage means exploiting mispricing in the market to your advantage and any profit thus gained is risk-free. Use this understanding to formulate a response to this question.

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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Suppose that the spot price of gold is US$1,700 per ounce. The quoted 1- year forward price of gold in the market is US$1,800, whereas it should have been $1,785. The 1-year US$ interest rate is 5% per annum. On the basis of the given information, answer the following: a) Is there an arbitrage opportunity? Why? b) If there is an arbitrage opportunity, show how will you exploit it? What will be the arbitrage profit? Hint: Recall that arbitrage means exploiting mispricing in the market to your advantage and any profit thus gained is risk-free. Use this understanding…
You are an investor in the world where short-selling assets is prohibited. Suppose that the price of asset X in period 0 is $200. This asset will pay a dividend of $8 one year from now in period 1. Let the riskless interest rate from 0 to period q be 5%.Assume the price for a future contract delivery in period 1 is $210. a) Can you make an arbitrage profit when $210 is the price? If so, state specifically what financial transaction? b) Now, assume the price for a futures contract with delivery in period 1 is K190. Can you make an arbitrage profit when this is the price? If so, state specifically what financial transaction you would make in 0 and period 1 to realize a profit. If not, explain?
This question will compare two different arbitrage situations. Recall that arbitrage should equalize rates of return. We want to explore what this implies about equalizing prices. In the first situation, two assets, A and B, will each make a single guaranteed payment of $100 in 1 year. But asset A has a current price of $80 while asset B has a current price of $90.a. Which asset has the higher expected rate of return at current prices? Given their rates of return, which asset should investors be buying and which asset should they be selling?b. Assume that arbitrage continues until A and B have the same expected rate of return. When arbitrage ceases, will A and B have the same price?Next, consider another pair of assets, C and D. Asset C will make a single payment of $150 in one year while D will make a single payment of $200 in one year. Assume that the current price of C is $120 and that the current price of D is $180.c. Which asset has the higher expected rate of return at current…
You are given the following data on gold markets. What is the level of arbitrage profits that can earned? • Current spot price of gold = $1,275 • Futures price for a 1-year contract = $1,300 • 1-year risk free interest rate = 3% • Assume that there are no carrying costs or yield on buying/selling gold.
consider a one-year forward contract on gold. Suppose that it costs $2 per ounce per year to store gold with payment being made at the end of the year. Assume that the spot price is $450 per ounce and the risk-free rate is 7% per annum for all maturities. Assume continuous compounding. (a) What is the forward price F (0, 1) that does not result in arbitrage profit? (b) If the forward price is $460, do you get any arbitrage profit opportunity? If so, what is your strategy? (You need to provide more than "buy low, sell high".)
Consider the following money market information being quoted: Which of the following statements is true? Particulars GBP Interest Rate THB Interest Rate Spot Rate 1-year Expected Spot Rate Bid Rate 6.100% 10.550% THB5.6601/GBP THB5.9037/GBP C. Ask Rate 6.125% 10.625% THB5.6622/GBP THB5.9961/GBP a. There is an arbitrage which can only be made by initially borrowing GBP and then investing in THB. b. More than one of the options in this question are correct. The THB is selling at a premium to the GBP in the future. O d. There is an arbitrage which can only be made by initially borrowing THB and then investing in GBP.
Assume that spot rate of New Zealand dollar is AUD 0.64/NZD, the 1-year forward rate of New Zealand dollar is AUD 0.62/NZD, 1-year interest rate on NZD is 9% and 1-year interest rate on AUD is 6%. If there is a possible arbitrage opportunity, the appropriate arbitrage strategy should be and the rate of return from covered interest arbitrage would be arbitrage; %. Select one: a. Inward; 0.38 b. Outward; 9.42 c. Inward; 9.42 d. Outward; 0.38
a. If the spot price of gold is $1,500 per troy ounce, the risk-free interest rate is 2%, and storage and insurance costs are zero, what should be the forward price of gold for delivery in one year? Use an arbitrage argument to prove your answer.b. Show how you could make risk-free arbitrage profits if the forward price is $1,550.
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.
Suppose the gold price is $300/oz., the 1-year forward price is 310.686, and the continuously compounded risk-free rate is 5%. a. What is the lease rate? b. Demonstrate a cash-and-carry strategy that provides the zero cash flow at time 0 and the maturity date. (You borrow to buy gold, sell the gold forward, and lend the gold, earning the lease rate.) c. What is the return on a cash-and-carry strategy in which gold is not loaned? (You borrow to buy gold and sell the gold forward.)
Assume you have the following asset and liability in your Balance Sheet: Asset - Bond A Modified Duration = 2.6 years Value = RM1.5 million Liability - Bond B Modified Duration = 3.1 years Value = RM1.0 million a. Calculate the duration gap. b. What is the expected change in Net Worth if interest increases by 1%? c. What should or could you to achieve immunised balance sheet? Note: Please show all workings.
It is given that dP/dt = rP (r being the annually compounded interest rate and P is the amount in the account at any given time). Suppose that an account earns at an annual rate of r percent compounded continuously and a person is drawing an income of H dollars per year withdrawn continuously (impossible, but a modeling assumption). Use phase line analysis to analyze the behavior of the account. Discuss the meaning of any equilibrium points and their stability. If r = 10% (a reasonable rate for long-term stock investments), and H = $10,000, how long should an initial investment of $50,000 be left untouched so that when withdrawals begin the capital is not depleted?

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