Consider a 1year futures contract on an investment asset tha

Consider a 1-year futures contract on an investment asset that provides no income. It costs $2 per unit to store the asset, with the payment being made at the beginning of the year. Assume that the spot price is $400 per unit and the risk free rate is 10% per annum for all maturitiesb) If currently the bid and ask on this 1-year futures contract are $444.5 and S445 respectively, what will you do? Please be specific and describe what this would imply? c) If this asset provides a lump sunm income distribution mid year that was S50, what would happen. (This is the important queston, please focus on this question. S 1S

Solution

The future price should be = (400 + 2)*1.10 = 442.20

so one can go short the futures contract since the futures price is overpriced currently

if there is a distribution in between the future price = 442.20 - 50*1.101/2 = 389.76

In such a case the actual future price of 444.5-445 is significantly higher than the breakeven price. While earlier it was almost equal, the addition of a cash flow brings in significant difference. Here too the future price currently is higher than the equilibrium price and one should go short on the futures contract.