Suppose there is a financial asset, a bond ABC, which is the underlying asset for a futures contract with settlement six months from now. You know the following about this financial asset and the futures contract:

-In the cash market ABC is selling for $80.

-ABC pays $8 per year in two semi-annual payments of $4, and the next semi-annual

payment is due exactly six months from now.

-The current six-month interest rate at which funds can be loaned or borrowed is 6%.

Respond to these questions:

a. What is the theoretical (or equilibrium) futures price?

b. What action would you take if the futures price is $83?

c. What action would you take if the futures price is $76?

d. Suppose that ABC pays interest quarterly instead of semiannually. If you know that you can

reinvest any funds you receive three months from now at 1% for three months, what would

the theoretical futures price for six-month settlement be?

e. Suppose that the borrowing rate and lending rate are not equal. Instead, suppose that the

current six-month borrowing rate is 8% and the six-month lending rate is 6%. What is the

boundary for the theoretical futures price?

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