The futures contract for settlement in 4 months is trading at F0 = $6.35 and the cash market is trading at S1 = $6.42. The 4-month interest rate on a continuously compounded basis is 2 percent. What is the arbitrage trade that is available, the transactions and the arbitrage profit? Buy now at S1 with borrowed money and enter a short
Macrohedging
Hedging or hedge accounting is a risk-mitigation technique used to protect the current financial position from potential losses. Hedging is often confused with speculating. The major difference between the two is that hedging does not involve guessing, whereas speculation is based on guessing the direction of movement of the underlying asset to book profits.
Finance Mathematics
The area of applied mathematics known as mathematical finance, also known as quantitative finance or financial mathematics is concerned with the mathematical modeling of financial markets. The application of mathematical methods to financial problems is known as financial mathematics. A financial market is a place where people can exchange low-cost financial securities and derivatives. Stocks and bonds, raw materials, and precious metals, both of which are regarded as commodities in the stock markets, are examples of securities. It uses probability, statistics, stochastic processes, and economic theory as methods.
The futures contract for settlement in 4 months is trading at F0 = $6.35 and the cash market is trading at S1 = $6.42. The 4-month interest rate on a continuously compounded basis is 2 percent. What is the arbitrage trade that is available, the transactions and the arbitrage profit?
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Buy now at S1 with borrowed money and enter a short forward contract at Fo. At time T deliver the underlying, receive F0 and pay back the loan plus interest. Net profit is: $0.4200 |
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Buy now at S1 with borrowed money and enter a short forward contract at Fo. At time T deliver the underlying, receive F0 and pay back the loan plus interest. Net profit is: $0.0280 |
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Sell short S1 and invest proceeds at r and enter long a forward contract at Fo; at time T receive the underlying for F0, cover the short and also collect the principal plus from the bank. Net profit is: 0.1129 |
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