Question

On March 15 the cash SP500 is priced 1000. The SP500 futures contract which matures 9...

On March 15 the cash SP500 is priced 1000. The SP500 futures contract which matures 9 months later in December has a price of 1200. The risk-free interest rate over this 9-month period is 5% while the dividend yield is 3%. Would an investor be better of investing his money in the spot SP500 or buying the futures contract on this index?

better to invest in the spot market only if it increases more than the futures market over this 9-month period

better to invest in the futures market only if it increases more than the spot market over this 9-month period

better to invest in the spot market it cannot be determined since the price of the of futures contract and the price of the spot in December is not known on March 15

better to invest in the futures market

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Answer #1

We calculate the implied futures price by using the formula = 1000 x exp[(0.05-0.03)x3/4] = 1015.1. Hence, the investor can get the cash S&P500 right now and hold it for 9 months and sell the futures available right now to make an arbitrage profit. SO, he will be better off investing in the spot market itself. We don't know what the prices of the spot and futures be in December but looking from an investing perspective, it would be beneficial to buy and hold the S&P right now as it is available cheaper. Option C.

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