Question Possible Answer 1 Possible Answer 2 Please answer q

Question

Possible Answer 1

Possible Answer 2

Please answer question C. Please show all work.

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 maturities. b) If currently the bid and ask on this 1-year futures contract are $444.5 and $445 respectively, what will you do? Please be specific and describe what this would mpy jris asset provides a lump sum income distribution mid year that you forgot to estimate in a above would you still be confident about your suggestion in b? Please explain (C is the important question, so please elaborate on this question)

Solution

The answer to the question no c is as below:

We predict a mid year income of $50 for this second part.

                 Expiry price 400

            Expiry price 500

Thus the arbitrage profit will still stay the same at 52.05 at this strategy level even if we apply the mid year income to reduce the carrying cost of the asset.