2. Suppose that financial Asset ABC is the underlying asset for a futures contract with settlement six
Question:
2. Suppose that financial Asset ABC is the underlying asset for a futures contract with settlement six months from now. You know the following about this financial asset and the futures contract:
(i) In the cash market, ABC is selling for $80.
(ii) ABC pays $8 per year in two semiannual payments of $4, and the next semiannual payment is due exactly six months from now.
(iii) The current six-month interest rate at which funds can be loaned or borrowed is 6%.
a. What is the theoretical (or equilibrium) futures price?
b. What action would you take if the futures price is $83?
c. What action would you take if the futures price is $76?
d. Suppose that ABC pays interest quarterly instead of semiannually. If you know that you can reinvest any funds you receive three months from now at 1% for three months, what would be the theoretical futures price for sixmonth settlement?
e. Suppose that the borrowing rate and lending rate are not equal. Instead, suppose that the current six-month borrowing rate is 8% and the six-month lending rate is 6%. What are the boundaries for the theoretical futures price?
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