consider a one-year forward contract on gold. Suppose that it costs $2 per ounce per year to store gold with payment being made at the end of the year. Assume that the spot price is $450 per ounce and the risk-free rate is 7% per annum for allmaturities. Assume continuous compounding. (a) What is the forward price F (0, 1) that does not result in arbitrage profit? (b) If the forward price is $460, do you get any arbitrage profit opportunity? If so, what is your strategy? (You need to providemore than "buy low, sell high".)

Answer information:Step 1:Given :Rate of Interest = R = 7% per annumSpot Price = S(0) = $ 450 per…

Answered: consider a one-year forward contract on…

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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You are an investor in the world where short-selling assets is prohibited. Suppose that the price of asset X in period 0 is $200. This asset will pay a dividend of $8 one year from now in period 1. Let the riskless interest rate from 0 to period q be 5%.Assume the price for a future contract delivery in period 1 is $210. a) Can you make an arbitrage profit when $210 is the price? If so, state specifically what financial transaction? b) Now, assume the price for a futures contract with delivery in period 1 is K190. Can you make an arbitrage profit when this is the price? If so, state specifically what financial transaction you would make in 0 and period 1 to realize a profit. If not, explain?
This question will compare two different arbitrage situations. Recall that arbitrage should equalize rates of return. We want to explore what this implies about equalizing prices. In the first situation, two assets, A and B, will each make a single guaranteed payment of $100 in 1 year. But asset A has a current price of $80 while asset B has a current price of $90.a. Which asset has the higher expected rate of return at current prices? Given their rates of return, which asset should investors be buying and which asset should they be selling?b. Assume that arbitrage continues until A and B have the same expected rate of return. When arbitrage ceases, will A and B have the same price?Next, consider another pair of assets, C and D. Asset C will make a single payment of $150 in one year while D will make a single payment of $200 in one year. Assume that the current price of C is $120 and that the current price of D is $180.c. Which asset has the higher expected rate of return at current…
a. If the spot price of gold is $1,500 per troy ounce, the risk-free interest rate is 2%, and storage and insurance costs are zero, what should be the forward price of gold for delivery in one year? Use an arbitrage argument to prove your answer.b. Show how you could make risk-free arbitrage profits if the forward price is $1,550.
Suppose the gold price is $300/oz., the 1-year forward price is 310.686, and the continuously compounded risk-free rate is 5%. a. What is the lease rate? b. Demonstrate a cash-and-carry strategy that provides the zero cash flow at time 0 and the maturity date. (You borrow to buy gold, sell the gold forward, and lend the gold, earning the lease rate.) c. What is the return on a cash-and-carry strategy in which gold is not loaned? (You borrow to buy gold and sell the gold forward.)
Suppose that the spot price of gold is US$1,700 per ounce. The quoted 1- year forward price of gold in the market is US$1,800, whereas it should have been $1,785. The 1-year US$ interest rate is 5% per annum. On the basis of the given information, answer the following: a) Is there an arbitrage opportunity? Why? b) If there is an arbitrage opportunity, show how will you exploit it? What will be the arbitrage profit? Hint: Recall that arbitrage means exploiting mispricing in the market to your advantage and any profit thus gained is risk-free. Use this understanding…
Suppose initially that two assets, A and B, will each make a single guaranteed payment of $400 in 1 year. But asset A has a current price of $280 while asset B has a current price of $320. Instructions: Round your answers to 2 decimal places. a. What are the rates of return of assets A and B at their current prices? Return on assetA =| |percent Return on asset B = percent Given these rates of return, which asset should investors buy and which asset should they sell? Buy asset (Click to solect) v and sell asset (Click to select) b. Assume that arbitrage continues until A and B have the same expected rate of return. When arbitrage ends, will A and B have the same price? (Click to select) Next, consider another pair of assets, C and D. Asset C will make a single payment of $600 in 1 year, while D will make a single payment of $800 in 1 year. Assume that the current price of C is $440 and that the current price of D is $680. c. What are the rates of return of assets C and D at their…
The current spot price of gold is $1200 per ounce. The riskless interest rate is 10% per annum. For simplicity, assume there are no storage/security costs of gold. a) What is the arbitrage-free forward price for the delivery of gold in 8 month's time?
An investment has an installed cost of $537,800. The cash flows over the four-year life of the investment are projected to be $212,750, $229,350, $196,010, and $144,720, respectively. a. If the discount rate is zero, what is the NPV? (Do not round intermediate calculations.) b. If the discount rate is infinite, what is the NPV? (A negative answer should be indicated by a minus sign.) c. At what discount rate is the NPV just equal to zero? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) a. NPV b. NPV c. IRR %
2. An investment has an installed cost of $412,670. The cash flows over the four-year life of the investment are projected to be $212,817, $153,408, $102,389, and $72,308. If the discount rate is zero, what is the NPV? If the discount rate is infinite, what is the NPV? At what discount rate is the NPV just equal to zero? Sketch the NPV profile for this investment based on these three points.
You are given the following data on gold markets. What is the level of arbitrage profits that can earned? • Current spot price of gold = $1,275 • Futures price for a 1-year contract = $1,300 • 1-year risk free interest rate = 3% • Assume that there are no carrying costs or yield on buying/selling gold.
An investment has an installed cost of $532,800. The cash flows over the four-year life of the investment are projected to be $216,850, $233,450, $200,110, and $148,820, respectively. a. If the discount rate is zero, what is the NPV? (Do not round intermediate calculations.) b. If the discount rate is infinite, what is the NPV? (A negative answer should be indicated by a minus sign.) c. At what discount rate is the NPV just equal to zero? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) a. NPV b. NPV c. IRR Q % l
Suppose you are offered a project with the following payments: Year Cash Flows 0 $ 9,800 1 −5,300 2 −4,000 3 −3,100 4 −1,700 a. What is the IRR of this offer? Note: Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16. b. If the appropriate discount rate is 15 percent, should you accept this offer? c. If the appropriate discount rate is 21 percent, should you accept this offer? d-1. What is the NPV of the offer if the appropriate discount rate is 15 percent? Note: A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16. d-2. What is the NPV of the offer if the appropriate discount rate is 21 percent? Note: A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.

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