Suppose we observe the following:
Current spot or cash price = $100
Interest rate (both borrowing and lending) = 8% (continuous rate)
Dividend rate on asset = 2% (continuous rate)
No transaction costs and the asset can be both costlessly stored and sold short.
1. Suppose the price of one year forward contracts is $110. Explain how you could construct a riskless arbitrage and calculate the profits.
2. Suppose the price of one year forward contracts is $100. Explain how you could construct a riskless arbitrage and calculate the profits.
3. Given the results in 1 and 2, what can we say about what the price of one year forward contracts should be if the spot price is $100? Explain.
(1)
(2)
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