A trader owns silver as part of a long-term investment portfolio. The trader can buy silver...

A trader owns silver as part of a long-term investment portfolio. The trader can buy silver today for $34 per ounce and sell silver today for $33 per ounce. The trader has indicated that there is no arbitrage opportunity if the lending rate is 8% p.a. (or less) and the borrowing rate is 9% p.a. (or more) with continuous compounding frequency. Assume that there is no bid-offer spread for forward prices, and that there is no storage cost and no convenience yield.

Required: Calculate the range within which the one-year silver forward prices must fall so that there is no arbitrage opportunity. Assume the trader can short sell silver if required.

Solutions

Expert Solution

To calculate the range within which one year silver forward rate should fall so that there is no arbitrage oppurtunity, we should first evaluate the option a trader has today to earn an arbitrage profit

1)Borrow today to buy silver and short sell silver after one year

Purchase price of silver-$34(S1)

Borrow-$34

r1(Borrowing Rate)-9%

Amount Payable after one year(With continous compounding)=S1*e^(r1*t)

34*e^(0.09*1)=34*2.7183^(0.09)=36.468

2)Sell stock today at spot price, invest the proceeds and buy after one year

Proceeds from sale of one ounce of silver-$33(S2)

Rate of return(Lending)-8%(R2)

Period of investment-t

Proceeds after one year-S2*e^(R2*t)

33*2.7183^0.08=$35.12

Comment on option 1-In order to have no arbitrage profit, the forward price should be $36.468

Option 2-In 2nd scenario, in order to have no arbitrage profit, forward price of one ounce of silver should be $35.12

Therefore in order to have no arbitrage position , one year silver forward price should fall in range of $35.12-$36.47

jeff jeffy answered 1 year ago

Next > < Previous

Related Solutions

Challenge question II Tyler wants to buy a beach house as part of his investment portfolio....

Challenge question II Tyler wants to buy a beach house as part of his investment portfolio. After searching the coast for a nice home, he finds a house with a great view and a hefty price of $4,500,000. Tyler will need to borrow from the bank to pay for this house. Mortgage rates are based on the length of the loan, and a local bank is advertising fifteen-year loans with monthly payments at 7.125%, twenty-year loans with monthly payments at...

Can expansionary gaps produce investment in the long term? true or false

A foreign exchange trader working for a bank enters into a long forward contract to buy...

A foreign exchange trader working for a bank enters into a long forward contract to buy one million pounds sterling at an exchange rate of 1.6000 in three months. At the same time, another trader on the next desk takes a long position in 16 three-month futures contracts on sterling. The futures price is 1.6000 and each contract is on 62,500 pounds. Within minutes of the trades being executed the forward and the futures prices both increase to 1.6040. Both...

Problem 16-05A a-d (Part Level Submission) The following securities are in Wildhorse Company’s portfolio of long-term...

Problem 16-05A a-d (Part Level Submission) The following securities are in Wildhorse Company’s portfolio of long-term securities at December 31, 2020. Cost 1,200 shares of Willhite Corporation common stock $60,000 1,200 shares of Hutcherson Corporation common stock 69,600 1,000 shares of Downing Corporation preferred stock 26,000 On December 31, 2020, the total cost of the portfolio equaled total fair value. Wildhorse had the following transactions related to the securities during 2021. Jan. 20 Sold all 1,200 shares of Willhite Corporation...

Part 1 – Current and long-term investments: From the perspective of a potential long-term investor, describe...

Part 1 – Current and long-term investments: From the perspective of a potential long-term investor, describe what you might look for when examining the assets of a corporation. Include in your answer an understanding of how short-term assets and long-term operating assets are different and what role they each play in a company’s performance. Part 2 - What might the different asset balances indicate to you as they change from year-to-year? Part 3 - What relationships would you look for...

A company is considering a long term investment project. It will require an investment of $128,300....

A company is considering a long term investment project. It will require an investment of $128,300. Useful life is 4 years. No salvage value. Annual cash inflows would increase $80,300 and annual cash outflows would increase $40,400. The company's required rate of return is 9 percent. Calculate the net present value of this project

Part I A) The solubility of silver bromide can be increased by dissolving it in a...

Part I A) The solubility of silver bromide can be increased by dissolving it in a solution containing the thiosulfate anion. AgBr(s) Ag+ (aq) + Br- (aq) K1 = 7.7 x 10-13 Ag+(aq) + 2S2O32- (aq) Ag(S2O3)23- (aq) K2 = 4.7 x 1013 What is the value of the equilibrium constant for the overall reaction? AgBr(s) + 2S2O32-(aq) Ag(S2O3)23-(aq) + Br-(aq) a) 12.4x1013 b) 3.6x10-9 c) 4.7x10-9 d) 4.7x1013 e) 36 B) Consider the following reaction at...

-Suppose you are the owner of a large portfolio of long-term bonds in the health care...

-Suppose you are the owner of a large portfolio of long-term bonds in the health care industry and you believe that in the next three years, all healthcare will be socialized to the public sector. You anticipate that the profits of most healthcare companies will suffer immensely from this new path. If the market agrees with your assessment of the future, what would you anticipate would be the near term consequences for your bond portfolio? Why would this happen and...

The additional incentive that the purchaser of a Treasury security requires to buy a long−term security...

The additional incentive that the purchaser of a Treasury security requires to buy a long−term security rather than a short−term security is called the A. term premium. B. tax premium. C. market premium. D. risk premium.

The use of long-term debt is a traditional part of the fiscal policy of state and...

The use of long-term debt is a traditional part of the fiscal policy of state and local governments. True or False When a lease payment is made, an entry is made in the debt service (or appropriate governmental) fund to record an expenditure, and an entry is made in the governmental activities accounts to reduce Lease Obligations Payable. True or False The use of encumbrance accounting is required for debt service funds. True or False Debt service funds for term...

Subjects