Question

You lend $1,000 at 10% per year for three months and proceed to short sell Asset XYZ for $1,000 in the cash market. You are required to pay $75 to the lender of Asset XYZ (which is the proceeds the lender would have received). You then immediately buy a futures contract at $950 for delivery of asset XYZ in three months (this will cover your short position). What is the net profit or loss from your strategy of lending money, short selling, and buying the futures contract?

It'd be great if I could get a step-by-step solution for this, thanks!

Answer 1

Gain or loss = Inflow - outflow ,

The total money after 3 months (principal + interest) = Amount lended X (1+i),

i = interest for the period, here 10% x 3/12 = 0.025 or 2.5%, 1000 X 1.025 = $1,025 the amount required to be paid to the lender of security = $75, payment for execution of Futures Contract = $ 950,

Here there is no profit or loss on this strategy, because our inflow (principal + interest) after 3 months = our outflow (payment for futures contract and lender of Security, so there is no gain or loss.