The current spot price of gold is $1000 per ounce. The riskless interest rate is 10% p.a.
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Question:
The current spot price of gold is $1000 per ounce. The riskless interest rate is 10% p.a. annually compounded.
a) John wants to sell gold in a year's time, which position (long or short) will John take in the futures market to hedge the price risk of gold? (1 mark)
b) From John's viewpoint, what are the pros and cons of hedging? (2 marks)
c) What is the arbitrage-free futures price for the delivery of gold in a year time? (1 mark)
d) If the price of a 1-year futures contract is quoted at $1120 per ounce, provide an example of a strategy that yields arbitrage profit. (Provide details including all the cash flows now and 1 year from now.) (4 marks)
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