Answer: Buy the futures contract and sell the underlying.

The correct answer is B, which involves buying the futures contract and selling the underlying equity index. This strategy is based on index arbitrage, where a discrepancy exists between the theoretical value of the futures contract and its current market price. The theoretical value of the futures price is calculated using the formula: \[ (F_0,t) = S_0 \cdot e^{(r - q) \cdot t} \] where: - \( S_0 \) is the current spot price of the index (USD 3,625), - \( r \) is the continuously compounded risk-free rate (5% per year), - \( q \) is the continuously compounded dividend yield (2% per year), - \( t \) is the time to contract expiration in years (15 months, or 1.25 years). Plugging in the values, the theoretical futures price is: \[ (F_0,t) = 3,625 \cdot e^{(0.05 - 0.02) \cdot 1.25} = USD 3,763.52 \] Since the current futures price is USD 3,759.52, which is lower than the theoretical price of USD 3,763.52, an arbitrage opportunity exists. By selling the higher-priced stocks underlying the equity index (or shorting the index) and buying the futures contract at the current price, an investor can lock in a risk-free profit. This is because the futures contract is underpriced relative to the theoretical value, allowing for a potential arbitrage profit.

Author: LeetQuiz Editorial Team