Assume that the continuous annual risk-free rate is 6% and the current spot price of the S&P
Question:
Assume that the continuous annual risk-free rate is 6% and the current spot price of the S&P 500 is $1,600.
a.) If the continuous dividend yield is 1.5%, what is the prepaid forward price for a contract with 3 years to maturity?
b.) What should be the normal forward price on a contract maturing in 3 years?
c.) If the observed normal forward price is $1,800, how would you develop an arbitrage strategy to take advantage of any mis-pricing?
d.) What would be the arbitrage profit from the strategy in part c?
e.) Show a payoff table that the arbitrage strategy will have zero net cash flow at all points in time and a guaranteed positive payoff in at least one time period.
Corporate Finance
ISBN: 978-0077861759
10th edition
Authors: Stephen Ross, Randolph Westerfield, Jeffrey Jaffe