The spot price of an investment asset is $25 and the risk-free rate is 8%, 8.5% and 9.5% for one-year-, two-year- and three-year-maturity, respectively. The asset provides an income of $4 at the end of the first year and at the end of the second year.

*Note: all interest rates are quoted with continuous compounding in this problem

#1) What should be the three-year forward price for no arbitrage opportunity?

#2) What is the initial value of this forward contract?

#3) If the 3-year forward price in the market is quoted as $21, what arbitrage opportunities does this create?

#4) How much of the arbitrage profit is realized?

#1 is $23.85

#2 is $0

#3 is long forward contract, and short the underlying asset in the spot market & invest $25 at risk-free rate

• invest PV of $4 at 8% for 1year
• invest PV of $4 at 8.5% for 2year s
• invest the remainder ($17.93) at 9.5% for 3year

I need help with #4