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On November 1, the one-month LIBOR rate is 4.0 percent and the two-month LIBOR rate is 5.0 percent.
Assume that Fed funds futures contracts trades at a 25 basis point rate under one-month LIBOR at the start of the delivery month. The December Fed funds futures is quoted at 94.75.
Assuming no basis risk between Fed funds and one-month LIBOR at the start of the delivery month, identify whether an arbitrage opportunity is available. Contract size is $5,000,000.
Be sure to illustrate the arbitrage strategy for one contract. To show the dollar arbitrage, assume the one-month LIBOR rate on December 1 was 7 percent.
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