Assignment_2_Solution

Assignment_2_Solution - QUESTION 1 If F2 > F1e r t2 t1 an...

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QUESTION 1: If ) ( 1 2 1 2 t t r e F F > an investor could make a riskless profit by (a) taking a long position in a futures contract which matures at time 1 t (b) taking a short position in a futures contract which matures at time 2 t When the first futures contract matures, an amount of 1 F is borrowed at rate r for time 1 2 t t . The funds are used to purchase the asset for 1 F and store it until time 2 t (assume no storage cost). At time 2 t it is exchanged for 2 F under the second contract. An amount of ) ( 1 1 2 t t r e F is required to repay the loan. A positive profit of ) ( 1 2 1 2 t t r e F F is realized at time 2 t . This type of arbitrage opportunity cannot exist for long. Hence we have: ) ( 1 2 1 2 t t r e F F . QUESTION 2: Suppose at time t we hold the following two positions: (a) long position in the forward contract and an amount of ) ( t T r Ke in bank account (b) ) ( t T q e unit of underlying asset
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This note was uploaded on 11/02/2011 for the course ACTSC 446 taught by Professor Adam during the Winter '09 term at Waterloo.

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Assignment_2_Solution - QUESTION 1 If F2 > F1e r t2 t1 an...

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