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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 cashandcarry and reverse cashandcarry.
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 riskfree 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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 Spring '08
 Pirim

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