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(15 points) The spot price of 1 lb of frozen orange juice is $1. We model the storage cost to hold frozen orange juice as

  1. (15 points) The spot price of 1 lb of frozen orange juice is $1. We model the storage cost to hold frozen orange juice as a continuous flow of 4% per year of the current value of the frozen orange juice. The 6-month spot rate is 2%. There is a forward contract written on 15,000 lbs of frozen orange juice and the current forward price is $1 per lb. You can enter a long or short position in the forward.

    1. (10 points) Suppose frozen orange juice was an investment asset and there is no convenience yield. Carefully describe an arbitrage strategy.

    2. (5 points) How large does the convenience yield have to be such that there is no arbitrage?

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