Question

Please note the strategy "buy low sell high" as at time t=1 NOT t=0. Suppose the...

Please note the strategy "buy low sell high" as at time t=1 NOT t=0.

  1. Suppose the 1-yr forward price of a barrel of oil is $20 and current oil price is $18. The cost of carry equals $20.5 (interests = $1.5 and storage fee and insurance =$1. How to make money without risk and with your own money? (100 pts.)

Today (t=0)

One year from today (t=1)

You buy and store a barrel of oil at ____

You deliver a barrel of oil

or

or

sell a barrel of oil at $_____

You save storage for $_________

If the price at t=1 is $21

You buy a forward contract at $____

You buy a barrel of oil at _____

or

or

Sell a forward contract at $____

You sell a barrel of oil at _______

Note: Only borrowing and lending in this section.

You borrow $_________

You payoff your debt and storage fee $_______

or

or

You lend $________

You receive $_________

Your initial investment (your own money) $________

Your profit _$_____________
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Homework Answers

Answer #1

Current oil barrel price+ interests+insurance = 18+2.5 = $20.5

Forward price = $20

Since Current oil barrel price+ interests+insurance > Forwards price, a reverse cash-and-carry arbitrage opportunity exists.

t=0 t=1 Explanation
You sell a barrel of oil at $18 You save storage for $1 Use the oil barrel received from the forward position to close out this position
You buy a forward contract at $0 You buy a barrel of oil at $20 Buying the barrel of oil at $20 ( Current market price is $21)
You lend $18 You receive $19.5 $1.5 is the interest cost received
Your initial investment $0 Your profit $2.5 $1 saved ( buy buying forward at $20 and selling oil at $21) and $1.5 interest from lending $18)
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