Question
With the information provided you should be able to (1) determine if there are arbitrage opportunities and (2) explain how those arbitrage opportunities can be
- With the information provided you should be able to (1) determine if there are arbitrage opportunities and (2) explain how those arbitrage opportunities can be exploited.
- The answers should be laid out clearly in numbered steps with simple sentences indicating:
- When the trade is happening
- If you are buying/selling
- If the action is taking place in the spot/forward market
- When will the action mature
- Show all cashflows and indicate the level of profits.
- If the steps are not clearly explained they will not be considered
- When the trade is happening
- If you are buying/selling
- If the action is taking place in the spot/forward market
- When will the action mature
- Show all cashflows and indicate the level of profits.
- If the steps are not clearly explained they will not be considered
Suppose you are a speculator who lives in a world where there are two islands: Island A and Island B. These two islands produce and trade rice. Today, the spot price for rice in both islands is trading at 320 cts/bushell and the storage costs in either island is 40 cts/bushell for a period of two weeks. Additionally, since these two islands trade, you can buy shipping to take from one island to the other one. The cost of shipping is 30 cts/bushell from one island to the other and it takes two weeks from the time it leaves one port to reach the final destination. Shipping is a complex process since it requires the grain to be loaded into containers, then stacked and secured inside the vessel along with everyone elses cargo. Today, the 2-week forward with delivery in Island A is trading at 360 cts/bushell and the 2-week forward with delivery in Island B is trading at 340 cts/bushell. Can you arbitrage this market and how much do you stand to earn for every unit traded? (Suppose you dont have an initial cash position, but that the interest rate is zero percent).
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started