Chapter 23, Problem 25PS

a.

Summary Introduction

To compute: The value by which a contract is mispriced with the help of given information.

Introduction:

Future contract: It is supposed to be a legal agreement required to purchase or sell a commodity or asset in the future. This contract will specify the price at which the purchase or sale of the commodity or asset should be done at a specified time which will be agreed by the parties in advance.

b.

Summary Introduction

To prepare: A zero-net-investment arbitrage portfolio to show that riskless profits can be equalized to futures mispricing.

Introduction:

Zero-net investment arbitrage strategy: According to this startegy, the securities should be purchased or sold in such a manner that the net result i.e., net investment becomes zero.

c.

Summary Introduction

To evaluate: The existence of arbitrage opportunity assuming the short sales of the stock in market index and the income is not received.

Introduction:

Arbitrage opportunity: It is an opportunity which can be availed to make a risk-free profit even in market fluctuations. The process of arbitrage involves buying of an asset in one market with a lesser price and sell it another market with a higher price.

d.

Summary Introduction

To compute: The no-arbitrage band for the stock-futures price relationship. Given stock index of 1900.

Introduction:

No-arbitrage: No-arbitrage can also be called as arbitrage- free principle. According to this principle, the price of the derivative is fixed in such a way that no one involved in trading can make a risk-free profit by purchasing one and selling the other.