Two non-dividend-paying stocks ABC and XYZ are both trading at $12 per share. Assume that the price of ABC is expected to be $10 in a year and the price of XYZ is expected to be $20 in a year.

(9.1) Should the one-year forward price of ABC be lower than the one-year forward price of XYZ? Why?

(9.2) Suppose the one-year forward prices for ABC and XYZ are both $13. What is your expected payoff in one year if you short one share of ABC forward and long one share of XYZ forward? Is this an arbitrage strategy?

(9.3) If the one-year forward price of ABC is $9 per share and the one-year forward price of XYZ is $19 per share, find an arbitrage strategy. You may buy or short sell only 1 share of ABC in the spot market. You are free to trade other types of securities. Describe your action now and in one year. Will you ever lose?

Answer rating: 100% (QA)

Stock Price Expectations and Arbitrage Strategies 91 OneYear Forward Price Comparison Yes the oneyear forward price of ABC should be lower than the on... View the full answer