Consider a long forward contract to purchase a non-dividend-paying stock in 3 months. Assume the current...

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Consider a long forward contract to purchase a non-dividend-paying stock in 3 months. Assume the current...

Consider a long forward contract to purchase a non-dividend-paying stock in 3 months. Assume the current stock price is $40 and the risk-free interest rate is an APR of 5% compounded quarterly. If the market forward price is $43, show explicitly the arbitrage opportunity.

note: this is not continuous compounding but discrete! so please do not use the Se^(rT) ( exponential formula)

business finance

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Answer 1

Answer #1

Price of forward should be =40*(1+5%/4)^1=40.500000

As market price is greater, sell forward and borrow money to buy the asset at spot

t=0:
Borrow 40
Buy Spot
Sell forward

t=3 months:
Return 40.5
Get 43 from forward

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Answer 2

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