Borrow or deposit at the riskfree rate

Reference no: EM13551389

Assume that a two-month forward contract (100 shares per contract; cash settlement at maturity) is written on a stock that will not pay any dividend in the next two months.
Assume that:
* The forward contract can be traded at $100 per share right now (with long or short position);
* Riskfree rate (borrow or deposit) is quoted as APR=12%, compounded monthly;
* There is no margin requirement or collateral required for forward contract, short sales, or loan;
* At the riskfree rate, you are also allowed to deposit your proceeds received from short sales.

(a) How do you synthesize (create) a portfolio (with shares and cash position) that will have the same settlement cashflow in two months as if you are holding one forward contract with long position (forward buyer). Specify exactly how many shares you need to buy (or short sell) and how much cash you need to borrow or deposit at the riskfree rate.

(b) Assume that the stock now can be traded at $100 (to buy or to sell). How do you form an arbitrage strategy to take advantage of this?
(Need to show the components of your arbitrage portfolio and arbitrage cashflows to justify that your arbitrage strategy works!)

(c) Assume that the stock now can be traded at $50 (to buy or to sell). How do you form an arbitrage strategy to take advantage of this?
(Need to show the components of your arbitrage portfolio and arbitrage cashflows to justify that your arbitrage strategy works!)

(d) (10 Points) What will be the "right" price for the stock right now in order to prevent arbitrage opportunity?

(e) If the stock is currently traded at the "right" price as you find in (d) and if the stock market reaches a consensus that the expected value of the stock is $120 at the end of two month, what can you conclude about the overall risk preference of the market?

Reference no: EM13551389

Questions Cloud

How far from home plate would the ball land if not caught : A batter hits a fly ball which leaves the bat 0.88above the ground at an angle of 62 with an initial speed of 28 heading toward centerfield. Ignore air resistance. How far from home plate would the ball land if not caught? T

Calculate the torque delivered by the motor : A 1.0kg grindstone in the shape of a uniform cylinder of radius 0.25m acquires a rotational rate of 18 rev/s from rest over a 6.4s interval at constant angular acceleration. Calculate the torque delivered by the motor

Modify the energy conservation equation : Briefly explain how we modify the Energy Conservation equation when there is work don't by forces outside of our system of interest? Be clear on what the modification means in terms of the total energy within our system.

Axis of the rod is perpendicular to the direction of wire : A small conductive rod of length 2 m moves with a constant velocity v=17 m/s in a direction parallel to a long wire carrying a current of 26 A. The the axis of the rod is perpendicular to the direction of the wire and the distance between the wire..

Borrow or deposit at the riskfree rate : How much cash you need to borrow or deposit at the riskfree rate.

Define how many tablets are needed for a dose of vitamin c : One commercial over the counter product consists of 500.0 mg tablets that are 20 percent by mass vitamin C. How many tablets are needed for a 1.00 g dose of vitamin C

Find its angular momentum relative to the origin : A particle whose mass is 2 kg moves in the xy plane with a constant speed of 3 m/s in the x direction along the line y = 5. What is its angular momentum (in kg×m2/s) relative to the origin

Calculate the velocity of the target ball after collision : A softball of mass 0.200 that is moving with a speed of 7.1 collides head-on and elastically with another ball initially at rest. Afterward the incoming softball bounces backward with a speed of 3.4 .Calculate the velocity of the target ball after th..

Find what is the angle of refraction in the water : Light propagating in the glass n1= 1.65 wall of an aquarium tank strikes the interior edge of the wall with incidence angle 19.0 degrees . What is the angle of refraction in the water

User Account

All Pages