--%>
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 : Types of lease contracts What are the

    What are the types of lease contracts which are seen in practice?

    		•
  • Q : Is it correct to use valuation of

    Is this correct to use in the valuation of the shares of a certain company the “the real net assets value” which, as per to the Institute of Accounting and Auditing (ICAC), shows the “book value of shareholder’s equity, corrected through increa

    		•
  • Q : Weighted return and simple return to

    What is the difference between weighted return and simple return to shareholders?

    		•
  • Q : Problem on sales collections The 2010

    The 2010 income statements of Leggett and Platt, inc. reports net sales of $4,076.1 million in 2010 and $4,250 million in 2009. The balance sheet reports accounts and other receivables, net of $550.5 million at December 31, 2010 and $640.2 million at December 31, 2009

    		•
  • Q : Problem about commercial and fiscal

    A court assigned to me (as an auditor and economist) a valuation of a market butcher’s. The butcher’s did not give any simple income statements or any valuable information that I could use in my valuation. This is a small business with just two workers, th

    		•
  • Q : Calculating Beta when market

    A company with a market capitalization of $100 million has no debt and a beta of 0.8. What will its beta be after it borrows $50 million (giving that there are no other changes and no taxes)?

    		•
  • Q : Who explain match theoretical & market

    Who demonstrated that how to match theoretical and market prices for normal bonds?

    		•
  • Q : Explain realization of name valuation

    I suppose that a valuation consciously realized in my name tells me how much I have to offer for the company, am I right?

    		•
  • Q : Affect the value of the stock Is the

     Is the value of this stock dependent on how long you plan to hold it? In other words, if your planned holding period were 2 years or 5 years rather than 3 years, would this affect the value of the stock today, P0? Explain your answer.<

    		•
  • Q : Problem on Bank branch networks While

    While banks across the United States and Europe are cutting down their number of branches, the number of bank branches in Hong Kong has increased in the same period. Hong Kong Monetary Authority statistics show the number of bank branches in Hong Kong at the end of 20

    		•