The futures contract for settlement in 4 months is trading at F0 = $6.35 and the cash market is trading at S1 = $6.42. The 4-month interest rate on a continuously compounded basis is 2 percent.  What is the arbitrage trade that is available, the transactions and the arbitrage profit?     Buy now at S1 with borrowed money and enter a short

Essentials Of Investments
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Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
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Chapter1: Investments: Background And Issues
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The futures contract for settlement in 4 months is trading at F0 = $6.35 and the cash market is trading at S1 = $6.42. The 4-month interest rate on a continuously compounded basis is 2 percent.  What is the arbitrage trade that is available, the transactions and the arbitrage profit?

   

Buy now at S1 with borrowed money and enter a short forward contract at Fo. At time T deliver the underlying, receive F0 and pay back the loan plus interest. Net profit is: $0.4200

   

Buy now at S1 with borrowed money and enter a short forward contract at Fo. At time T deliver the underlying, receive F0 and pay back the loan plus interest. Net profit is: $0.0280

   

Sell short S1 and invest proceeds at r and enter long a forward contract at Fo; at time T receive the underlying for F0, cover the short and also collect the principal plus from the bank. Net profit is: 0.1129

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