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Question 685  future, arbitrage, no explanation

An equity index stands at 100 points and the one year equity futures price is 107.

The equity index is expected to have a dividend yield of 3% pa. Assume that investors are risk-neutral so their total required return on the shares is the same as the risk free Treasury bond yield which is 10% pa. Both are given as discrete effective annual rates.

Assuming that the equity index is fairly priced, an arbitrageur would recognise that the equity futures are:




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