PROBLEM 3: Arbitrage connects the prices of different instruments in a portfolio and helps to keep...
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PROBLEM 3: Arbitrage connects the prices of different instruments in a portfolio and helps to keep everything correctly or "fairly" priced. Whenever Fo,t Soet, prices are not in equilibrium and there may be profitable arbitrage opportunities. a) Suppose the hedge fund can borrow at 3% (annualized) and lend at 1%. Find the upper and lower bounds on the no-arbitrage range if stocks are currently trading at 3900 and the investment time horizon is 6 months. Carry out your calculations to 4 decimals. b) An investment bank will let you buy or sell a 6-month forward on these stocks at 4000. Should you buy or sell this forward? PROBLEM 3, cont.: c) Use the grid below to show how you would profitably arbitrage this forward. Be sure to indicate the instruments you would use, whether each position is long or short and include (+) and (-) signs on your cash flows. Also show your net profit. Transaction: Total: Time 0 cash flows: Time t cash flows: d) Same as Part b) above, but now suppose the investment bank has priced the forward at 3950. Without doing any calculations, what should you do? Explain your answer. PROBLEM 3: Arbitrage connects the prices of different instruments in a portfolio and helps to keep everything correctly or "fairly" priced. Whenever Fo,t Soet, prices are not in equilibrium and there may be profitable arbitrage opportunities. a) Suppose the hedge fund can borrow at 3% (annualized) and lend at 1%. Find the upper and lower bounds on the no-arbitrage range if stocks are currently trading at 3900 and the investment time horizon is 6 months. Carry out your calculations to 4 decimals. b) An investment bank will let you buy or sell a 6-month forward on these stocks at 4000. Should you buy or sell this forward? PROBLEM 3, cont.: c) Use the grid below to show how you would profitably arbitrage this forward. Be sure to indicate the instruments you would use, whether each position is long or short and include (+) and (-) signs on your cash flows. Also show your net profit. Transaction: Total: Time 0 cash flows: Time t cash flows: d) Same as Part b) above, but now suppose the investment bank has priced the forward at 3950. Without doing any calculations, what should you do? Explain your answer.
Expert Answer:
Answer rating: 100% (QA)
Solving the Arbitrage Problem Part a NoArbitrage Range We can find the noarbitrage range using the cost of carry framework Heres how Upper Bound In th... View the full answer
Related Book For
Intermediate Accounting
ISBN: 978-0132162302
1st edition
Authors: Elizabeth A. Gordon, Jana S. Raedy, Alexander J. Sannella
Posted Date:
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