Question 2

1. Identify the differences between futures and forward contracts.

1. The two-month interest rates in the US and France are 3% and 6% per annum respectively with continuous compounding. The spot price of dollars is 0.9000. The futures price for a contract deliverable in two months is 0.9200.

Required:

a)Evaluate whether the circumstances above create an arbitrage opportunity.

b)Describe in detail how an arbitrageur might take advantage of these circumstances.

c)The spot price of oil is $110 per barrel and the cost of storing a barrel of oil for one year is $6, payable at the end of the year. The risk free rate of interest is 4% per annum continuously compounded. Calculate the one year futures price of oil.

d) A share is expected to pay a dividend of 2 in two months and in five months. The share price is 15 and the risk free rate of interest is 7% per annum with continuous compounding for all maturities. An investor has just taken a long position in a six month forward contract on t he share.

In three months, the price of the share is 10. The risk free rate of interest is unchanged. Calculate the forward price and the value of the long position in the contract.