Name: SHOAIB IFTEKHAR SHAKIL

ID:17304026

Homework 1 Forward Contracts

(Deadline: Before Wednesday’s Live Session, October 21)

1. A stock with the current price of $55 can be purchased by the following different
ways.
 Outright purchase at $55
 Fully leveraged purchase at the risk-free interest rate of 5%/year
 Prepaid Equity forward contract at a discounted price from the forward
price
 Enter an Equity Forward contract at the forward price of $59
 Maturity for the forward contract is 1 year

Assume that there is no settlement risk and dividend from holding the stock. And the
stock is actively traded both in long and short positions on a secondary market. Fill in
the blank cells in the table below and show at least two different strategies to gain
arbitrage profits from this situation.

Description Cash Flow at T0 Cash Flow at T1 Profit/Loss

Outright Purchase -55 +S1 +S1-55(1.05)
Leveraged Purchase 0 +S1-55(1.05) +S1-55(1.05)
Buy Forward 0 +S1-59 +S1-59
Prepaid forward -56.19 +S1-56.19(1.05) +S1-59

Arbitrage Strategy 1: Buy Spot + Sell Forward

Description Cash Flow at T0 Cash Flow at T1 Profit/Loss
Outright Purchase -55 +S1 +S1-55(1.05)
Sell Forward 0 -S1+$59 $59-S1
Net CF -55 $59 $1.25
Arbitrage Strategy 2: Leveraged Purchase + Sell Forward
Description Cash Flow at T0 Cash Flow at T1 Profit/Loss
Leveraged Purchase 0 +S1-$55(1+0.05) +S1-$57.75
Sell Forward 0 -S1+$59 $59-S1
Net CF 0 $57.75 $1.25