I) A refiner has 250 tons of CPO in inventory. He will be holding this over the next 3 months. He intends to protect himself from a fall in the price of CPO which could cause him losses since his output price tied to CPO prices.

He has the following information.

Current inventory = 250 tons

Spot price = $1100 per ton

Interest rate = 6% per year

Annual storage cost = $44 per ton (4% per annum)

3-month CPO futures = $ 1126.53 per ton

a) Prove that the hedge strategy will lock-in the value of his inventory, in two possible price scenarios for the CPO in 90 days as follows:

i. Scenario 1: Suppose CPO price rises 20% (to $ 1,320 per ton)

ii. Scenario 2: Suppose CPO price falls 20% (to $ 880 per ton)

II) Suppose on a certain day, you notice the following quotes.

CPO spot price = RM 980 per ton

Risk-free rate = 6% per year

Annual storage cost = 4% per year (RM 39.20 per ton)

3-month CPO futures = $ 1,013.63 (90 days to maturity)

a. Is arbitrage possible? How would you arbitrage? explain (250 to 300 word)

b. Suppose the price at maturity is RM 1,015, what would your profit be if you are willing to invest in 50 tons?