Reference no: EM132959903

Problem 1: Suppose that gold, which does not pay any dividends and has no convenience value, is currently trading at 1350 USD per ounce in the spot market. The LIBOR rate is 2% per year and the cost of storing and insuring gold is 1.50 USD per ounce for 180 days, payable at the end of the period. Based on these, determine the theoretical price of a forward contract on gold that has 180 days till maturity.

Problem 2: Assume that your bank quotes you forward prices of 1360 (bid) and 1362 (ask) for a 180- day forward contract on gold. Also assume that you can borrow and lend at a 2% per year interest rate, store gold or receive storage payments for gold at 1.50 dollars per ounce for 180 days, and that you can buy or short gold in the spot market at 1350. Do these set of prices present an arbitrage opportunity? If your answer is yes, describe precisely how you would take advantage of it and calculate the arbitrage profit per ounce.

Problem 3: Remark briefly on the fact that the set of transactions you enter into in part (b) are through a bank and not a clearinghouse. Specifically, if one were to hold these arbitrage positions till forward settlement date, what can go wrong in this 180-day holding period that would affect their profitability?