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27 September, 02:26

A futures contract on corn that matures exactly 6 months from now is trading at $3.32 per bushel. The spot price of corn is $3.20. If the continuously compounded annual risk-free rate is 5%, then the arbitrage strategy right now is: Multiple Choice Short the futures contract; Borrow at the risk-free rate; Long corn; Long the futures contract; Borrow at the risk-free rate; Short corn; Short the futures contract; Invest at the risk-free rate; Long corn; Long the futures contract; Invest at the risk-free rate; Short corn;

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  1. 27 September, 02:32
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    Short the futures contract; Borrow at the risk-free rate; Long corn;

    Explanation:

    Spot rate = $3.20

    Therefore implied future rate = spot x ert

    Therefore implied future rate = 3.20 x e0.05 x 6/12

    Therefore implied future rate = 3.20 x 1.025315

    Therefore implied future rate = 3.281

    Since implied future rate < future rate, we will short future contract and borrow and buy at spot

    Therefore, 1st choice is correct
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