--%>
Assignment Help - homework help

Problem on arbitrage opportunity

John Chan considers purchasing a six-month stock futures contract on the shares of Li & Fung Limited. Shares of Li & Fung Limited are now presently trading at $50 per share and it is predicted that Li & Fung Limited will pay a dividend of $1 per share in one and four months. The risk free interest rate is around 5% per annum with continuous compounding.

a) Compute the estimated price of the six-month Li & Fung Limited stock futures contract.

b) When the actual futures price of Li & Fung Limited shares is $50, is there any arbitrage opportunity? Outline the steps needed to do the arbitrage.

E

Expert

Verified

a) Based on the theoretical pricing model we get the following:-

Futures Price = Underlying stock price X (1+ annualized interest rate – dividend)
Underlying stock price is $ 50 per share . Rate of interest = 5% and dividend is $1 per share
$50 x ( 1+ .005 - $ 1 per share
$ 50 x ( 1.05-1)= $ 2.5
Futures price will be $ 50+$2.5= $ 52.5

b) The attempt to make a profit by exploiting the differences in identical stocks or any financial instruments is defined as arbitrage. In the above case the actual future price being $ 50 is the same as the current trading price and hence there is no arbitrage opportunity.

   Related Questions in Corporate Finance

  • Q : Calculate valuation realized by

    Is a valuation realized through a prestigious investment bank a scientifically approved result that any investor could utilize as a reference?

    		•
  • Q : Company Valuation Project Hello, Need a

    Hello, Need a top-notch finance expert to complete a company valuation assignment for me for a class. Will attach details. Please inform me if you have your graduate level resource who is good with company valuations and executive summary writeup of the analysis please. English writing skills ar

    		•
  • Q : What are Workpapers Workpapers : In

    Workpapers: In finance world, work papers are documents which are created during the procedure of computing the financial records of a business or individual. The accounting professional which is tasked with examining the book-keeping of a business mi

    		•
  • Q : Does the equity of shareholders have

    Does the equity of shareholders represents the savings a company has accumulated by the years?

    		•
  • Q : Convertible Bonds-Corporate Bonds State

    State the term Convertible Bonds in Corporate Bonds?

    		•
  • Q : Illustrates financial consultant has

    A financial consultant obtains various valuations of my company when this discounts the Free Cash Flow (FCF) as opposed to when this uses the Equity Cash Flow. Is it correct?

    		•
  • Q : Effective annual yield problem Stanley

    Stanley invested in a municipal bond which promised an annual yield of 6.7 %. The bond pays coupons twice a year. What is the effective annual yield (abbreviated as EAY) on this investment? (1) 13.4%  (2) 6.81%  (3) 6.70%  (4) None of the above

  • Q : Finance You expect KT industries (KTI)

    You expect KT industries (KTI) will have earnings per share of $3 this year and expect that they will pay out $1.50 of these earnings to shareholders in the form of a dividend. KTI's return on new investments is 15% and their equity cost of capital is 12%. The value of a share of KTI's stock is clos

    		•
  • Q : Explain the structure

    Our company (A) is going to buy the other company (B). We need to value the shares of B and, thus, we will use three options of the structure Debt/Shareholders’ Equity in order to obtain the WACC as: 1) Present structure of A

    		•
  • Q : Explain consensus among the chief

    Is there any consensus among the chief authors in finance concerning the market risk premium?

    		•