Consider a one-year futures contract on 100 oz of gold. We assume no income and that it costs $3.00 per ounce per year to store gold. The spot price is $1900 per ounce and the risk-free rate is 10% per annum for all maturities. This corresponds to r=0.10, S_0=1900, T=1, and U=3e^(-0.1×1)=2.85, so that the equilibrium price is given by F_0^*=(S_0+U) e^rT=(1900+2.85) e^(0.1×1)=2102. What arbitrage opportunity is possible if the futures price for a contract is $2,200 or $2,000?

Case 1: F0=$2,200>F0*=$2,102 overpriced forward (underpriced spot asset)

Today: short forward & long spot assets by borrowing

At maturity:

Case 2: F0=$2,000<F0*=$2,102 underpriced forward (overpriced spot asset)

Today: long forward & short spot assets and invest

At maturity:

Answer rating: 100% (QA)

Case 1 F02200F02102 overpriced forward underpriced spot asset If the futures price for the contract ... View the full answer