Assume the risk-free rate is constant at 2.5%, please find out the possible arbitrage opportunity given the following information.
3-month futures price: $100
6-month futures price: $105
Risk free rate is constant @ 2.5%
therefore risk free rate from the end to 3 months to the end of 6 months = 2.5%
Therefore implied forward rate for 6 months = 100 x (1+2.50% x 3 /12) = $100.625
Therefore arbitrage is possible
Buy 3 month futures @ $100
Sell 6 month futures @ $105
Pay the above amount ($100) at the end of 3rd month by borrowing for 3 months
Therefore amount to be repaid after 6 months = $100 x (1+2.50% x 3 /12) = $100.625
Amount receivable from sell of 6 month future = $105
Therefore arbitrage gains (received at the end of 6 months)= $105 - $100.625 = $ 4.375
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