Question

It is now January. The current annual interest rate is 4.6%. The June futures price for gold is $1655.90, while the December futures price is $1,663. Assume the June contract expires in exactly 6 months and the December contract expires in exactly 12 months. a. Calculate the appropriate price for December futures using the parity relationship? (Do not round intermediate calculations. Round your answer to 2 decimal place.) b. Is there an arbitrage opportunity here? No Yes

Answer 1

a. If we assume the June Futures prices to be correct, I would have to find the December Futures Prices in accordance with the June Futures prices. Considering annual interest rate of 4.6%, we have-

1655.9 x (1+0.046/2) = 1693.9857.

Hence, the December Futures prices should be 1693.9857.

b. Yes, there is an arbitrage opportunity here because the actual price of the December Futures contract is $1663 which is less than the implied price. So, take advantage of this opportunity, we can buy the Dec contracts from the market at the lower price and wait till December. When December comes, the price of the futures would have changed and we would sell our futures then.