Question

Is there an arbitrage opportunity in any of the following situations? Please show clearly why or why not?

a. The spot price of gold is US1,898.50 per ounce, the 6-month forward rate is US$1,910 per ounce and the US$ interest rate is 0.11% per annum. There is no income or storage costs for gold.  

b. The spot price of gold is US$1,895.50 per ounce, the 6-month forward rate is US$1,850 per ounce and the 6-month US$ interest rate is 0.11% per annum. There is no income or storage costs for gold.

Answer 1

  

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Answer a)

Fair Forwars Price = Spot Price * e^(r*t)

r = 0.0011

t = 0.50

= 1898.50 *e^(0.0011*0.50)

= 1898.50 * 1.00055015128

= 1899.54

1899.54 NOt equal to 1910. Therefore arbitrage opportunity is there,

Answer b)

Fair Forwars Price = Spot Price * e^(r*t)

r = 0.0011

t = 0.50

= 1895.50 *e^(0.0011*0.50)

= 1895.50 * 1.00055015128

= 1896.54

Since the Fair Price is not equal to the Forward Price. Arbitrage opportunity is there .

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