Question
2. (15 points) A futures contract is written on a stock. The maturity of the contract is 6 months. The stock price is $50 today
2. (15 points)
A futures contract is written on a stock. The maturity of the contract is 6 months. The stock price is $50 today and the risk-free rate is 10% per year with continuous compounding.
- What should the futures price for this contract be?
- Suppose that the futures price for this contract quoted by Trader A is $56.56, is the futures contract under-valued or over-valued? Explain your answer.
What arbitrage opportunity does this create? Use the following table to show your positions (in the futures contract, the underlying asset and cash account) on date t (today) and the expiration day T. Assume that the stock price on the expiration day T is $60.
Action | Cash Flow at t | Cash Flow at T |
1: (hint: long or short the stock?) |
|
|
2: (hint: long or short the forward contract ?) |
|
|
3: (hint: borrow or lend?) |
|
|
Total |
|
|
- Does your answer (e.g., the arbitrage profit) in (2) change if the stock price on the expiration day is $40 instead of $60? Explain your answer.
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