Fight Finance

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Your neighbour asks you for a loan of $100 and offers to pay you back$120 in one year.

You don't actually have any money right now, but you can borrow and lend from the bank at a rate of 10% pa. Rates are given as effective annual rates.

Assume that your neighbour will definitely pay you back. Ignore interest tax shields and transaction costs.

The Net Present Value (NPV) of lending to your neighbour is $9.09. Describe what you would do to actually receive a$9.09 cash flow right now with zero net cash flows in the future.

The price of gold is currently $700 per ounce. The forward price for delivery in 1 year is$800. An arbitrageur can borrow money at 10% per annum given as an effective discrete annual rate. Assume that gold is fairly priced and the cost of storing gold is zero.

What is the best way to conduct an arbitrage in this situation? The best arbitrage strategy requires zero capital, has zero risk and makes money straight away. An arbitrageur should sell 1 forward on gold and:

A non-dividend paying stock has a current price of $20. The risk free rate is 5% pa given as a continuously compounded rate. A 2 year futures contract on the stock has a futures price of$24.

You suspect that the futures contract is mis-priced and would like to conduct a risk-free arbitrage that requires zero capital. Which of the following steps about arbitraging the situation is NOT correct?

A non-dividend paying stock has a current price of $20. The risk free rate is 5% pa given as a continuously compounded rate. Options on the stock are currently priced at$5 for calls and $5.55 for puts where both options have a 2 year maturity and an exercise price of$24.

You suspect that the call option contract is mis-priced and would like to conduct a risk-free arbitrage that requires zero capital. Which of the following steps about arbitraging the situation is NOT correct?

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