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Assume no storage costs in this problem. Also, assume continuous compounding.

Consider the following forward prices on an investment asset

Forward prices (cents/unit of the asset) as of February

Mar 270.25

May 275.25

Use the above information on March and May forward prices to determine the spot price of the asset and risk-free rate in February at which there should be no profitable arbitrage opportunities.

Now let us assume that the observed risk-free rate is different from your answer to the above question (i.e. either higher or lower than the risk-free rate you obtained above). Can you clearly outline a trading strategy in February to exploit any arbitrage opportunities?

Financial Management, Finance

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