Question

Assume that a bank can borrow or lend money at the same interest rate in the...

Assume that a bank can borrow or lend money at the same interest rate in the LIBOR market. The 91-day rate is 5% per year, and the 182-day rate is 5.2%. Assume the LIBOR rates are continuously compounded. The Eurodollar futures price for a contract maturing in 91 days is quoted as 96.

  1. Could you find any arbitrage opportunities?                         
  1. How would you conduct the arbitrage? What should be the arbitrage profit?

Homework Answers

Answer #1

Equilibrium for Forward Rate Agreements:

LHS = e​​​​​​R​​​​​2 T​​​​2 = e ^ 0.052 * 6/12 = 1.02634

182 days LIBOR is 5.2% (R2) * 6/12 (T2) which is continuously compounded

RHS = e​R T x e r t  = e ^ 0.05* 3/12 x e ^ 0.04*3/12

= 1.0258 x 1.0101 = 1.03616

R = LIBOR 91 days rate T is 91 days

r = 100 -96 = 4 (Eurodollar futures trading at 4% discount)

t = 91 days

RHS > LHS

Arbitrage occurs if Investor borrows for 6 months at 5.2% and invests for 3 months at 5%. Buys Eurodollar 91 day futures.

Know the answer?
Your Answer:

Post as a guest

Your Name:

What's your source?

Earn Coins

Coins can be redeemed for fabulous gifts.

Not the answer you're looking for?
Ask your own homework help question
Similar Questions
A bank can borrow or lend at LIBOR. Suppose that the six-month rate is 5% and...
A bank can borrow or lend at LIBOR. Suppose that the six-month rate is 5% and the nine-month rate is 6%. The rate that can be locked in for the period between six months and nine months using an FRA is 9%. What arbitrage opportunities are open to the bank? All rates are continuously compounded.
A bank can borrow or lend at LIBOR. Suppose that the six-month rate is 5% and...
A bank can borrow or lend at LIBOR. Suppose that the six-month rate is 5% and the nine-month rate is 6%. The rate that can be locked in for the period between six months and nine months using an FRA is 9%. What arbitrage opportunities are open to the bank? All rates are continuously compounded.
Today is April 1st. A bank needs to borrow $100 million on May 15th by selling...
Today is April 1st. A bank needs to borrow $100 million on May 15th by selling 90-day Eurodollar deposits. Bank’s Treasury desk is looking into derivatives contracts for hedging the bank’s risk and is interested in the June Eurodollar futures contract with a current price of 93.25 and a contract size of $1 million. Explain the risk faced by the bank in the spot market and determine the futures position that the Treasury desk should take in order to hedge...
1. The bank you are working for needs to borrow $100 million on May 15 th...
1. The bank you are working for needs to borrow $100 million on May 15 th by selling 90-day Eurodollar deposits. Your bank’s Treasury desk is looking into derivatives contracts for hedging the bank’s risk and is interested in the June Eurodollar futures contract with a current price of 93.25 and a contract size of $1 million. a. Explain the risk faced by your bank in the spot market and determine the futures position that the Treasury desk should take...
Assume that the only cost (or opportunity cost) associated with gold is the “interest on the...
Assume that the only cost (or opportunity cost) associated with gold is the “interest on the money” if you own gold. There are no storage costs and the convenience yield is zero. Suppose you can borrow or lend money at 10 percent per annum (continuous compounding) if you buy / sell gold. Today's price of gold is $1,320 per ounce, and there are also gold futures contracts available. The 6-month gold futures is trading at $1,370 and the 12-month gold...
First American Bank is planning to make a $20 million short-term loan to Midwest Mining Company....
First American Bank is planning to make a $20 million short-term loan to Midwest Mining Company. In the loan contract, Midwest agrees to pay the principal and an interest of 12 percent (annual) at the end of 180 days. Since First American sells more 90-day CDs (Certificates of Deposits) than 180-day CDs, it is planning to finance the loan by selling a 90-day CD now at the prevailing LIBOR of 8.25 percent (compounded annually), then 90 days later (mid-September) sell...
First National Bank is somehow able to borrow money at an interest rate of 4% while...
First National Bank is somehow able to borrow money at an interest rate of 4% while lending at a rate of 8%.  Therefore, the bank can be said to be engaging in interest rate: Manipulation Arbitrage Speculation Fraud
First American Bank is planning to make a $20 million short-term loan to Midwest Mining Company....
First American Bank is planning to make a $20 million short-term loan to Midwest Mining Company. In the loan contract, Midwest agrees to pay the principal and an interest of 12 percent (annual) at the end of 180 days. Since First American sells more 90-day CDs (Certificates of Deposits) than 180-day CDs, it is planning to finance the loan by selling a 90-day CD now at the prevailing LIBOR of 8.25 percent (compounded annually), then 90 days later (mid-September) sell...
You have the following market data. Spot price of the Japanese Yen is $0.009185. Underlying asset...
You have the following market data. Spot price of the Japanese Yen is $0.009185. Underlying asset for the Japanese Yen futures contract is 12,500,000 Yen. 3-month Japanese LIBOR rate is 2.14% per year, and the 3-month U.S. LIBOR rate is 2.76% per year. Both rates are continuously compounded. Japanese Yen futures contract that expires in 3 months has a futures price of $0.009030. What is the general arbitrage strategy? A. Take a short position in the futures contract, borrow yen...
3. . Mod. 5: Hedging with Interest Rate Futures (Chapter 8, pp. 191 to 193). [Hints:...
3. . Mod. 5: Hedging with Interest Rate Futures (Chapter 8, pp. 191 to 193). [Hints: $ Price for T-bills and Eurodollar Futures:           $ Price = $ Amount {1 – [(d x n)/360]} where d = discount yield as a fraction; n = maturity, usually 90 days]           In March, a bank short-term investment manager has $1 million in 90 day T-bills on its balance sheet that it plans to sell in June for liquidity purposes, and is worried...
ADVERTISEMENT
Need Online Homework Help?

Get Answers For Free
Most questions answered within 1 hours.

Ask a Question
ADVERTISEMENT