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.

Answer rating: 100% (QA)

a To calculate the prepaid forward price with a continuous dividend yield of 15 we can use the formu... View the full answer