1. Suppose the current spot price for gold is $700 per ounce. The risk-free inte

Question

1.    Suppose the current spot price for gold is $700 per ounce. The risk-free interest rate available to all investors for borrowing or lending is 6% per month (monthly compounding). Forward contracts are available to buy or sell gold for delivery in 1 year; the forward price for gold is $790 per ounce. You have a large inventory of gold.

· 1- Assume that storage costs for gold are zero. Is there an arbitrage opportunity? If you answer “YES,” then show step by step how you would make a profit and calculate the profit per ounce of gold. If you answer “NO,” then show why there is no arbitrage opportunity.

· 2- Assume that the present value of the storage cost for gold is $100 per ounce for one year of storage. Is there an arbitrage opportunity? If you answer “YES,” then show step by step how you would make a profit and calculate the profit per ounce of gold. If you answer “NO,” then show why there is no arbitrage opportunity.

Explanation / Answer

Ans 1 Action Amount Buy one ounce gold in Spot Market Borrow the amount to buy the gold             700.00 Sell forward Contract in future market Settle the borrowed money along with interest             742.17 Cost of the Gold bought with Borrowed money             742.17 Sale value of the forward contract to be settled after one year             790.00 Net risk free gain               47.83 Workings Future Value of 700 700*(1+06/12)^12             742.17 Ans 2 Since cost of spot buy with interest and storage cost exceeds forward rate ,there is no arbitrage opportunity

Related Questions

Navigate

• Browse (All)
• Browse 1
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.