Observe the following market data:

• Silver forward contracts (settled in cash) that mature in 4 months have a forward price of $512 per ounce.

• Silver forward contracts (settled in cash) that mature in 8 months have a forward price of $520 per ounce.

• T-Bills that mature in 4 months have a continuously-compounded rate of return of 3% per year.

• T-Bills that mature in 8 months have a continuously-compounded rate of return of 5% per year.

Explain clearly and completely how to lock in an arbitrage profit today by taking positions in only T-Bills and forwards. Your strategy should give you a positive payoff today and lose no money (give a payoff of 0) in the future (specifically, in 4 months and 8 months). Calculate the arbitrage profit from your strategy. Assume silver has no storage costs or convenience yield. You do not need to know the spot price of silver today to answer this question. You can insert a table into your written answer in Canvas to clearly show the payoffs of your arbitrage strategy at each point in time. Hint: You can use forwards and T-bills to create a synthetic investment in silver.

Answer rating: 100% (QA)

To lock in an arbitrage profit we can create a synthetic silver investment using a combination of TB... View the full answer