--%>
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 : What is optimal capital structure What

    What is optimal capital structure?

    		•
  • Q : Explain deducing yield curve model

    Explain deducing yield curve model of HJM.

    		•
  • Q : Explain Value Chain Value Chain : The

    Value Chain: The value chain is a theory from business management that was first described and popularized Michel Porter in his 1985 best seller, Competitive Advantage: Creating and Sustaining Superior Performance.

  • 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 : Bond price problem ABC Corp is issuing

    ABC Corp is issuing a 10-year bond with a coupon rate of 7 %. The interest rate for similar bonds is at present 9 %. Supposing annual payments, what is the current value of the bond? (Round to the closest dollar.) (a) $872 (b) $1,066 (c) $990 (d) $945.

    Q : Relationship between flow to

    Is there any relationship in between the flow to shareholders and the net income?

    		•
  • Q : Structure of Interest rates Which

    Which determines the shape of the term structure of Interest rates?

    		•
  • Q : Does value of the company increase when

    According to the valuation method depends on tax shields, the value of the company (Vl) is the value of the unleveraged company (Vu) in addition with the value of tax shields (VTS), thus, the higher the interest and the higher the VTS. Therefore, does

    		•
  • Q : Problem on leveraged beta AB

    AB Restaurants has debt/equity ratio .25, and its leveraged beta is 1.5. Its tax rate is 30%, and its cost of equity is 15%. The risk-free rate is 5%. CD Restaurants has debt/equity ratio .4, and tax rate 35%. Find the cost of equity for CD.

    		•
  • Q : Which currency is utilized in an

    Which currency has to be utilized in an international acquisition in order to compute the flows?

    		•