Suppose for simplicity that the price of frozen concentrated orange juice is currently at $1000 per 10-pound contract and an investor who holds 10 pounds of FCOJ wishes to temporarily hedge her exposure to market risk. Assume that the cost of storing 10 pounds of FCOJ comes to $20 per year, and, for simplicity, all costs are paid at year-end and the risk-free interest rate is 1%.

(a) Calculate the appropriate Futures price for a 10-pound FCOJ contract using Spot-Futures Parity.

(b) Assume that the futures price for year-end delivery of the FCOJ contract is $1,010 (the parity is violated). Show how an investor can make arbitrage profits.

Answer rating: 100% (QA)

a Calculating Futures Price using SpotFutures Parity Spot Price F 1000 per 10pound contract Storage ... View the full answer