Suppose for simplicity that the price of frozen concentrated orange juice is currently at $1000 per 10-pound contract and an investor who holds 10 pounds of FCOJ wishes to temporarily hedge her exposure to market risk. Assume that the cost of storing 10 pounds of FCOJ comes to $20 per year, and, for simplicity, all costs are paid at year-end and the risk-free interest rate is 1%. (a) Calculate the appropriate Futures price for a 10-pound FCOJ contract using Spot-Futures Parity. (b) Assume that the futures price for year-end delivery of the FCOJ contract is $1,010 (the parity is violated). Show how an investor can make arbitrage profits.

Suppose for simplicity that the price of frozen concentrated orange juice is currently at $1000 per 10-pound contract and an investor who holds 10 pounds of FCOJ wishes to temporarily hedge her exposure to market risk. Assume that the cost of storing 10 pounds of FCOJ comes to $20 per year, and, for simplicity, all costs are paid at year-end and the risk-free interest rate is 1%. (a) Calculate the appropriate Futures price for a 10-pound FCOJ contract using Spot-Futures Parity. (b) Assume that the futures price for year-end delivery of the FCOJ contract is $1,010 (the parity is violated). Show how an investor can make arbitrage profits.

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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Similar questions

Consider a 6-month futures contract on a financial asset with dividend yield q=3.96% per year. Risk free rate is 10% per year. Current value of an asset is S0=$25. What should be the 6-month futures price on this asset, if there is no convenience yield and storage costs?
Suppose that the current spot price of corn is $720 per bushel. The one year risk-free rate is 6% per annum. The futures price for delivery of one bushel of corn in one year’s time is $792 per bushel. Assume that net costs (storage costs minus convenience yield) are $15 per bushel (over the next one year). Is the futures contract correctly priced? If not, what is the theoretically correct price for the futures contract and how could you take advantage of any mispricing? Please show full steps and explain.
Suppose you borrow $10,000,000 in the interbank money market at a KLIBOR yield of 6% pa for a term of 1 month.Should you buy or sell a KLIBOR futures contract if you were to hedge against interest rate risks? explain
The promised cash flows of three securities are listed below. If the cash flows are risk-free, and the risk-free interest rate is 5.0%, determine the no-arbitrage price of each security before the first cash flow is paid. Security Cash Flow Today ($) Cash Flow in One Year ($) A 800 800 B 0 1600 C 1,600 0 The no-arbitrage price of security A is how much? ? (Round to the nearest cent.) The no-arbitrage price of security B is how much? ? (Round to the nearest cent.) The no-arbitrage price of security C is how much? ? (Round to the nearest cent.)
Later, Linda believes that futures contracts on currencies can offer a greater return than futures contracts on indices. Consider storing a 3-year futures contract at a cost of MYR 6 per unit. Assume that the risk-free rate is 6% per year for all maturities and that the current price is MYR 760 per unit. Estimate the predicted price in the future. What will Linda do if she is an arbitrageur, and the real future price is higher than the predicted future price?
Assume that the Pure Expectations Theory of the term structure is correct. Also assume that the interest rate today on a 9-year security is 6.40%, while the interest rate today on a 15-year security is 8.00%. Finally assume that the interest rate on a 3-year security to be bought at Year 9 and held over Years 10, 11, and 12 is 6.80%. Given this information, determine the average annual return that investors today must expect that they will receive from investing in a 3-year security in 12 Years (that is, buying the security at Year 12 and holding it over Years 13, 14, and 15). O 13.00% O 12.50% 13.50% O 12.00% O 14.00%
A trader, Peter, buys a treasury note with a face value of 1000, which will mature in 180 days. Currently such T-notes are yielding 4.25% per annum. a) what amount will peter pay for the T-note? b) What is the annual rate of return (HPY) for peter? c) what is the current yield of maturity (YTM) for the security?
Suppose we have both a European call option and put option with an exercise price of $53 and the underlying stock is currently priced at $50. We are to note also that both options will expiry in six months. Further, market surveys suggest that the price of the stock can either go up by 20% or decrease by 25%. The current risk-free rate of interest is 2% per annum. Required: (a) What is the expected price of the underlying asset at expiry date? (b) What is the value of the call option, using the binomial model? (c) If the put option is selling for $4.80, what should be the price of the call option to avoid arbitrage?
6.Assume we have the following information: Spot price : 1146.00 Actual futures price : 1192.50 Theoretical futures price : 1160.00 Maturity : 3 months a. Is the futures fairly priced? Suppose an arbitrageur wish to take advantage of this opportunity. He has RM10,000,000.00 which he can fund at the current risk-free rate of 5%. b. What should he do? c. How many contracts should be shorted or bought? d. Assume that the arbitrageur maintains this position until contract expiry at which time futures and cash prices have converged to 1165. How much profit would he makes?
A call option has X=$52 and expire in 360 days (suppose we have 360 days in one year). The risk-free rate is 4%. The call is priced at $11. A put option has X-$52 and is priced at $1. The underlying asset is priced at S0=$43. Suppose in our investments, we could involve one call, one put, one bond, and on stock. How much arbitrage profit could we possibly obtain?
A European call that will expire in one year is currently trading for $3. Assume the risk-free rate (based on continuous compounding) is 5%, the underlying stock price is $60 and the strike price is $55. a. Is there an arbitrage opportunity? b. Describe exactly what a trader should do to take advantage of the arbitrage opportunity assuming it exists. c. Determine the present value of the profit that the trader can earn assuming you identify an arbitrage opportunity. Use at least four decimal places for those questions that require a numerical answer.
Suppose you borrow RM10,000,000 in the interbank money market at a KLIBOR yield of 6% p.a for aterm of 1 month. Should you buy or sell KLIBOR futures contract if you were to hedge against interest rate risks?

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