Question

1. What should be the one-year stock futures value for a stock with spot price of $100. Assume the one-year T-bill rate is 2.5% and dividend yield is 1%.

2. Can you conduct an arbitrage strategy If the actual futures price in the market is $100.50?

Answer 1

(a) futures price = spot price * e^(annual risk free rate - annual dividend yield)*time in years

futures price = $100 * e^(0.025 - 0.001)

futures price = $102.43

(b) If the actual futures price is $100.50, then the actual futures price is undervalued.

Yes, an arbitrage strategy can be conducted as the actual futures price is less than implied futures price

To conduct the arbitrate, buy the undervalued asset and sell the overvalued asset

In this case, buy the futures and sell the spot to earn an arbitrage profit