Suppose that you are an arbitrageur looking for opportunities to capitalize on mispriced securities.

You notice that the futures contract written on the HSBC, maturing in six months, may be mispriced. The current stock price of HSBC is HK$80 per share and it is expected that HSBC will pay a dividend of HK$1.20 per share six months later. The risk-free interest rate (continuously compounded) is 2% per annum.

Required

a. Demonstrate why you believe the HSBC futures contract is mispriced.

b. Suppose that the actual HSBC stock futures price is HK$78.50. Critically discuss the steps an arbitrageur can take to perform an arbitrage trading and evaluate the arbitrage profit per share.

Answer rating: 100% (QA)

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