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;

Question

Business

Rebekah Lucas

26 March, 13:42

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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Answers (1)

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Killian · Answer 1

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