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Answer: It involves selling a stock index futures contract and purchasing the portfolio of stocks underlying the index.
## Explanation Stock index arbitrage is a trading strategy that exploits pricing discrepancies between stock index futures contracts and the actual underlying portfolio of stocks that make up the index. **Correct Answer Analysis:** - **Option D** is correct because stock index arbitrage typically involves selling an overpriced stock index futures contract while simultaneously purchasing the basket of stocks that make up the index (or vice versa). This creates a risk-free arbitrage profit when the futures price deviates from its fair value relative to the spot index. **Incorrect Options Analysis:** - **Option A** describes spread trading between different futures contracts, not true index arbitrage. - **Option B** describes pairs trading or relative value trading within an index, not index arbitrage. - **Option C** is incorrect because arbitrage doesn't "ensure" the price relationship - it exploits temporary deviations from fair value, and the portfolio must be tradable for arbitrage to work effectively. **Key Concept:** Stock index arbitrage relies on the cost-of-carry model and helps maintain price efficiency between futures and spot markets by exploiting temporary pricing inefficiencies.
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Which of the following statements is correct regarding stock index arbitrage?
A
It involves purchasing one stock index futures contract and selling a different stock index futures contract.
B
It involves purchasing a basket of stocks that are members of an index while selling other stocks in the same index.
C
It ensures that the price of the index will always correspond to the value of a portfolio of the underlying stocks, even if the portfolio is not tradable.
D
It involves selling a stock index futures contract and purchasing the portfolio of stocks underlying the index.