Suppose you can borrow and lend at an annual interest rate of 6% per annum. The IBM stock is trading at $120. It is not going to pay any dividend in one year. Ignore all transaction costs.

(a) What is the fair forward price of a forward contract which calls for the delivery of 1 share of IBM stock at the end of one year?

(b) If the actual forward price is $129, is there an arbitrage opportunity (AO)? If yes, state your arbitrage strategy explicitly and analyze cash flows to show that this is indeed an AO.

Answer rating: 100% (QA)

a The fair forward price of a forward contract can be calculated using the formula for the forward p... View the full answer