PROBLEM SET #2 Due March 04, 2008 1) The current spot price is $43.5 and the current forward price for delivery in ¾ of a year is $44.30. You face a borrowing rate of 3% and a lending rate of 1.5%; both are quoted as continuously compounded rates. Assume you can freely take a long or short position in the spot. Can you arbitrage? Show the cash flows which make each type of arbitrage either profitable or unprofitable; both cash-and-carry and reverse cash-and-carry. 2) A bank offers a corporate client a choice between borrowing cash at 11% per annum and borrowing gold at 2% per annum. (If gold is borrowed, interest must be paid in gold. Thus, 100 ounces borrowed today would require 102 ounces to be repaid in 1 year.) The risk-free interest rate is 9.25% per annum, and storage costs are 0.5% per annum. Discuss whether the rate of interest on the gold loan is too high or too low in relation to the rate of interest on the cash loan. What should be the correct interest rate on gold loan? The interest rates on the two loans are expressed with annual
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This note was uploaded on 04/18/2008 for the course FIN 412 taught by Professor Pirim during the Spring '08 term at University of Illinois at Urbana–Champaign.