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The price of gold is currently 5000 SEK per gram. The forward price for delivery in...

  1. The price of gold is currently 5000 SEK per gram. The forward price for delivery in one year is 7000 SEK. An arbitrageur can borrow and lend money at 10% per annum. What should the arbitrageur do? Assume that the cost of storing gold is 1000 SEK.
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Answer #1

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Actual Forword price = Spot Price*(1+interest rate)+ Storage cost.

= 5000*(1.10)+1000

= 6500 SEK.

Given Forward Price = 7000 SEK.

As the Given Forward Price(7000 SEK) > Actual Forward price (6500 SEK)

The Given Forward Price is at a premium, hence we should Short the Forward.

Action which Arbitrageur should do:

1. Borrow money at 10%

2. Buy gold at 5000 SEK.

3. Store it at 1000SEK.

4. Sell Forward at 7000SEK.

Hence the Profit of 500SEK.

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