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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Transcribed Image Text: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.
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