Question
Today is January 1. Consider a July forward contract on soybeans (delivery date is July 1). The spot price of soybeans is 825.1 cents per
Today is January 1. Consider a July forward contract on soybeans (delivery date is July 1).
The spot price of soybeans is 825.1 cents per bushel, you can store soybeans until July 1 for 60 cents per bushel (paid in advance) and you can borrow or lend money at a 4% rate (annualized and continuously compounded).
Questions:
(a) What must the July forward price be in order to rule out arbitrage opportunities?
(b) Suppose the July forward price is 907.5 cents per bushel. Demonstrate how you could earn costless arbitrage profits. Be sure to clearly identify the amount of your profits and when they are received.?
(c) What prevents you from repeatedly executing the arbitrage in part (b) to earn unlimited profits?
Step by Step Solution
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Step: 1
a The July forward price must be equal to the spot price plus the cost of storage and financing In t...
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An Introduction to Derivative Securities Financial Markets and Risk Management
Authors: Robert A. Jarrow, Arkadev Chatterjee
1st edition
978-0393912937, 393912930, 393913074, 978-0393920949, 393920941, 978-0393913071
