Question
You are a market-maker and an arbitrageur in the forward market. An asset is trading for $120 and $110 in the spot and the forward
You are a market-maker and an arbitrageur in the forward market. An asset is trading for $120 and $110 in the spot and the forward market, respectively, and these prices seem to be out of line. The forward contract is set to expire on January 5, 2023. The term structure of U.S. money-market interest rates is provided in the table below. These rates are expressed in decimals. Today is January 5, 2022.
Term Ending date Rate
0x6 2022-04-06 0.00090
0x12 2022-07-07 0.00090
0x18 2022-10-06 0.00095
0x24 2023-01-05 0.00100
(A) Confirm that there exists a price disparity between the two markets and implement the arbitrage strategy that will enable you to exploit it. Spell out each step of your strategy carefully, in the proper sequence, and calculate the profit that you will derive from it. The contract size is 10,000 units of the asset.
B) As it turns out, the stock will pay SEK 10 per share in dividends on July 7, 2022. Does this explain the price disparity that you observe between the two markets in A)? If not, implement the strategy that will enable you to exploit it. Spell out each step of your strategy carefully, in the proper sequence, and calculate the profit that you will derive from it. The contract size is the same as in A).
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