Question

Assuming positive basis and negligible borrowing cost, which of the following transactions could yield positive arbitrage profits if pursued by a hedge fund? Multiple Choice Buy gold in the spot market, and sell the futures contract Buy the futures contract, and sell the gold spot and invest the money eamed. Buy gold spot with borrowed money, and buy the futures contract Buy the futures contract, and buy the gold spot using borrowed money. Prev 1 of 5 Next >

Answer 1

Option '1' is correct

Buy gold in the spot market, and sell the futures contract could yield positive arbitrage profits assuming on a positive basis and no borrowing costs.

Because if investor expects the price of the gold to rise in the future, the investor purchase the gold in the spot market and also sell a futures contract. on the maturity date the investor settles the contract at at a higher value and also sell the gold. The investor earns profit. (the above arbitrage profit can be achieved only if investor assumes a positive basis and no borrowing costs)