A corporate client has been offered a choice between borrowing cash and bor- rowing gold by a bank. Cash borrowing will be paid back in cash. Similarly, if gold is borrowed, interest must be repaid in gold. Thus, 100 ounces borrowed today would require 102 ounces to be repaid in 1 year. [hint: the cost of carry should be incorporated into calculating the forward price]

A) If the price of gold is $550 per ounce, calculate the one-year forward price of gold given the risk-free interest rate is 9.25% per annum, and storage costs are 0.5% per annum. The risk-free interest rate and storage costs are expressed with continuous compounding.

B) Due to the below average credit rating of the firm, the bank proposed to lend cash at 11% per annum or lend gold at 2% per annum. The interest rates on the two loans are expressed with annual compounding. Use the forward price of gold you calculated in part (A) above to determine if the rate of interest on the gold loan is too high or too low in relation to the rate of interest on the cash loan.

C) What should be the rate of interest on gold lending to make this corporate client indifferent between borrowing gold or cash from the bank?