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Essentials Of Investments
Found in: Page 592
Essentials Of Investments

Essentials Of Investments

Book edition 9th
Author(s) Zvi Bodie, Alex Kane, Alan Marcus, Alan J. Marcus
Pages 748 pages
ISBN 9780078034695

Short Answer

Joan Tam, CFA, believes she has identified an arbitrage opportunity for a commodity as indicated by the information given in the following exhibit:

a. Describe the transactions necessary to take advantage of this specific arbitrage opportunity.

b. Calculate the arbitrage profit.

a. The strategy of reserve, cash and carry should be adopted.

b. $4.60

See the step by step solution

Step by Step Solution

Step 1: Explanation on necessary transaction

To take advantage of the arbitrage opportunity, the strategy of reserve, cash and carry should be adopted.

This strategy results when the relationship F0t ≧ S0 (1 + C) doesn’t hold true.

If the future price is less than spot price plus transportation cost at a futures date, the arbitrage opportunity exists in the form of Reserve, Cash and Carry.

Step 2: Calculation of arbitrage profit

Opening transaction Now

Sell the spot commodity short

+ $120

Buy the commodity futures expiring in 1 years

0.00

Contract to lend $120 at 8% for a year

- $120

Total cash flow

0.00

Closing transaction One year from Now

Accept delivery on expiring futures

- $125

Cover short commodity position

0.00

Collect on loan of $120

+ $129.60

Total arbitrage profit

$4.60

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