On May 10th, 2012, the gold spot price was $1,580/oz and the 9-month risk-free i
ID: 2821959 • Letter: O
Question
On May 10th, 2012, the gold spot price was $1,580/oz and the 9-month risk-free interest rate was 2% (annualized),
Assume the cost of storage and insurance of gold is $100/oz payable on February 7th, 2013. Use actual/actual day count method and simple interest method.
a) What is the equilibrium price of gold futures on May 10th, 2012 for delivery in 273 days, February 7th, 2013?
b) If the futures price is $1,800, how can you create an arbitrage profit making strategy? What is the amount of arbitrage profit?
Explanation / Answer
In an ideal scenario, the gold futures price should be spot price plus the carrying cost plus the storage & insurance cost. Any other price will result in an arbitrage opportunity which should eventually lead to this equilibrium price. Note that we are using simple interest for compounding and not exponential (continous compounding) - the difference will be marginal in decimals.
(a) Equilibrium price = 1580 * (1+2%)(273/365) + 100 = 1703.58
(b) If the futures price is $1800, which is higher than the expected equilibrium price, the following can be done to profit from the arbitrage:
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.