QUESTION 3

Consider a long forward contract to purchase a coupon-bearing bond whose current price is 650. We will suppose that the forward contract matures in 9 months, and a coupon payment of 28 is expected after 4 months. We suppose that the 4-month and 9-month risk-free interest rates (continuously compounded) are 3% and 4% per annum.

Required:

a) Calculate the forward price.

(8 marks)

b) Is there an arbitrage opportunity if the forward price is relatively low at 600? List the possible arbitrage actions for

i) Now;

ii) In 4 months; and

iii) In 9 months.

(15 marks)

c) Critically evaluate why the futures prices of consumption assets are difficult to calculate.

(7 marks)