ARBITRAGE IN OUR CASE Assume that the interest rates for 2 years out are flat at 9%. If the one- year futures is trading in the market for $9,500, what will you do? If the one-year future is $9500 there is an arbitrage opportunity since the assed is undervalued according to our previous calculations which price the one-year future at $10,600. To take advantage of these mispriced futures we must buy the one-year future contract that's $9500 and short sell the index future for $10000. You will invest the $10000 you gain from the short sale at 9%. You will have $10900 by the end of the year, and you will have to buy the $9500 future contract. Value of arbitrage= $10900 (from investment)- $9500 (future) = $1400 after 1 year

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
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A Index has currently a value of $10,000, and pays a dividend yield of 3%. What should be the price of a futures contract on the index for delivery in 1 year and what for delivery in 2 years? Assume that the interest rates for 2 years out are flat at 9%. If the one-year futures is trading in the market for $9,500 what will you do?

2) show in a diagram or graph or illustration of how the abritrage opprotunity happens.

ARBITRAGE IN OUR CASE
Assume that the interest rates for 2
years out are flat at 9%. If the one-
year futures is trading in the
market for $9,500, what will you
do?
If the one-year future is $9500 there is an arbitrage opportunity since
the assed is undervalued according to our previous calculations which
price the one-year future at $10,600.
To take advantage of these mispriced futures we must buy the one-year
future contract that's $9500 and short sell the index future for $10000. You
will invest the $10000 you gain from the short sale at 9%. You will have
$10900 by the end of the year, and you will have to buy the $9500 future
contract.
Value of arbitrage= $10900 (from investment)- $9500 (future) = $1400 after
1 year
Transcribed Image Text:ARBITRAGE IN OUR CASE Assume that the interest rates for 2 years out are flat at 9%. If the one- year futures is trading in the market for $9,500, what will you do? If the one-year future is $9500 there is an arbitrage opportunity since the assed is undervalued according to our previous calculations which price the one-year future at $10,600. To take advantage of these mispriced futures we must buy the one-year future contract that's $9500 and short sell the index future for $10000. You will invest the $10000 you gain from the short sale at 9%. You will have $10900 by the end of the year, and you will have to buy the $9500 future contract. Value of arbitrage= $10900 (from investment)- $9500 (future) = $1400 after 1 year
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