• C++ Programming for Financial Engineering
    Highly recommended by thousands of MFE students. Covers essential C++ topics with applications to financial engineering. Learn more Join!
    Python for Finance with Intro to Data Science
    Gain practical understanding of Python to read, understand, and write professional Python code for your first day on the job. Learn more Join!
    An Intuition-Based Options Primer for FE
    Ideal for entry level positions interviews and graduate studies, specializing in options trading arbitrage and options valuation models. Learn more Join!

Can anyone help me with this simple model.

John Jones

Joined
4/14/13
Messages
2
Points
11
I'm having trouble with this question. (I am an undergraduate).

Given: stock is currently selling for $50 per share. A forward contract is available to buy 100 shares of the stock 3 months from now for $51 per share.

The payoff for the forward contract is given by X = Price at end of 3 months - 51

Bank is offering a 3 month CD with an interest rate of 8% compounded annually and you have 5000 in principal.

Using the CDs, Stocks, and forward contracts describe an arbitrage profit and the amount of the profit.

Any ideas as to how I can approach this? So far we have only discussed a finite binomial model for European contingent claims.

Thank you guys for any help or tips you may have.
 
borrow $5000 today and buy $5000/50 = 100 shares of stock
sell those 100 shares of stock 3m forward for 100*51 = $5100
you will owe $5000*(1+8%)^(1/4) = $97.13 in interest for the $5000 you borrowed
so you have made $5100-$5000 = $100 from the spot vs forward underlying price neutral transaction and you owe $97.13 in interest, meaning you have made $100-$97.13 = $2.87 in 3m out of thin air (arbitrage)
 
Back
Top