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Suppose the S&P 500 index is 1100 and that it is possible to lend at 4 % and borrow at 7 %. The index pays

Suppose the S&P 500 index is 1100 and that it is possible to lend at 4 % and borrow at 7 %. The index pays continuously compounded dividend yield of 2%.

a) Suppose you observe a 6-month price of forward price of 1133. What arbitrage would you

undertake?

b) Suppose you observe a 6-month price of forward price of 1109. What arbitrage would you

undertake?

Please show the cash flows, which make each type of arbitrage and explain

what you would do at each relevant date.

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