--%>
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 : Define Project Financing Project

    Project Financing: It is the procedure of determining how to go around obtaining the resources needed in managing the costs related with the launch and continuing operation of a project. Whereas this procedure sometimes comprises the re-allocation of

    		•
  • Q : Widgets You are required to submit a

    You are required to submit a bid to supply 200,000,000 widgets per year to the State of Illinois for the next five years. Your company has an idle tract of real estate that cost $1,500,000 ten years ago; if your company sold the land today, it would generate $3,000,000 after the taxes were paid. The

    		•
  • Q : Briefly describe the financial services

    1 FINANCIAL SERVICES BY BANKS Financial system facilitates the transformation of savings of individuals, government as well as business into investment and consumption. It consists of

    		•
  • Q : Explain lognormal random walk based on

    Explain lognormal random walk based on Brownian motion.

    		•
  • Q : Explain essential hypotheses for

    Which are the essential hypotheses so that valuations of the Economic Value Added (EVA) give similar results to discounting cash flows?

    		•
  • Q : What is the market risk premium What is

    What is the market risk premium within Spain at the present time – the number that I have to use in the valuations?

    		•
  • Q : Abnormal profits based on fundamental

    If it is possible to make abnormal profits based on fundamental analysis, you can conclude that the market is: A) Not weak-form efficientB) Weak-form efficientC) Not semi-strong-form efficientD) Semi-strong-form e

    		•
  • Q : Problem on implied exchange rate a) The

    a) The Australian firm sold a ship to a Swiss firm and gave the Swiss client an option of paying either AUS10,000 or SF15,000 in 9 months. (i) In above, the Australian firm efficiently gave the Swiss client a free option to buy up

    		•
  • Q : Problem on EBIT ABC Corporation stock

    ABC Corporation stock sells at $27 per share and its dividend per share is $1.20. ABC has price-earnings ratio of 16. The company contains $40 million worth of bonds, selling at par, with 8.5% coupon. The EBIT of ABC is of $12 million and its tax rate is 30%. Calculat

    		•
  • Q : Cost of capital You have joined Zurich

    You have joined Zurich Pvt. Ltd as a Finance manager. You are given the following information: Zurich Pvt Ltd. is a diversified manufacturing firm dealing with electrical appliances. In 2012, the firm reported an operating income of Rs. 857.60 million and faced a tax rate of 35% on income. The

    		•