4 Futures Contracts (6 marks)

The current spot price of gold is $100 per ounce. The riskless interest rate is 1% per month. For simplicity, assume there are no storage/security costs of gold.

a) If you need to sell the gold in 6 months' time, which position (long or short) will you take in the futures market to hedge the price risk of the gold? (1 mark)

b) What is the arbitrage-free futures price for the delivery of gold in 6 months' time? (2 marks)

c) If you see a 6-month futures price of gold quoted at $110 per ounce, explain how you would capture an arbitrage profit. Show your work in details by clearly outlining the actions, initial cash flow and cash flow at maturity (T). (3 marks)