Does risk-free arbitrage opportunity exist-general strategy

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Reference no: EM131554768

Consider a single-stock futures contract on Best Buy Co. The company will pay a quarterly dividend of $0.17 per share prior to expiration of the futures contract. Consider the following scenario. The stock goes ex-dividend in one month; for convenience, we will assume that the dividend is paid at that time. Assume that this dividend is the only one prior to expiration of the futures contract.

Annualized, continuously compounded risk-free interest rates: r1 = 3% for one month, and r2 = 4% for four months.

Current spot price of Best Buy stock: $23 per share.

Contract expiration: T = four months (1/3 of a year).

Futures price on Best Buy single-stock futures: $25 per share.

Does a risk-free arbitrage opportunity exist? If so, describe the general strategy.

a) Borrow at the risk-free rates, buy shares of Best Buy, and enter a short position in Best Buy single-stock futures.

b) Sell shares of Best Buy short, invest at the risk-free rates, and enter a long position in Best Buy single-stock futures.

c) Sell shares of Best Buy short, invest at the risk-free rates, and enter a short position in Best Buy single-stock futures.

d) Borrow at the risk-free rates, buy shares of Best Buy, and enter a long position in Best Buy single-stock futures

e) No arbitrage opportunity exists.

Reference no: EM131554768

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