Answer: Buy silver in the spot market and enter into a 6-month forward contract to sell silver.

## Explanation The relationship between the forward price and spot price of an investment asset with no income and no applicable storage costs can be evaluated with the basic no-arbitrage formula: \[ F = S(1 + R)^T \] Where: - \( F \) = Forward price - \( S \) = Spot price - \( R \) = Risk-free interest rate - \( T \) = Time to maturity **Given values:** - Spot price \( S = 24.70 \) - Forward price \( F = 25.00 \) - Risk-free rate \( R = 2\% = 0.02 \) - Time \( T = 0.5 \) years (6 months) **Calculate theoretical forward price:** \[ F_{theoretical} = 24.70 \times (1 + 0.02)^{0.5} = 24.70 \times (1.02)^{0.5} = 24.70 \times 1.00995 = 24.95 \] **Comparison:** - Actual forward price = 25.00 - Theoretical forward price = 24.95 Since the actual forward price (25.00) is **greater than** the theoretical forward price (24.95), the forward contract is **overpriced**. This creates an arbitrage opportunity. **Arbitrage strategy:** 1. Borrow money at the risk-free rate 2. Buy silver in the spot market at $24.70 3. Enter into a forward contract to **sell** silver at $25.00 4. At maturity, deliver the silver and receive $25.00 5. Repay the loan with interest: $24.95 6. Profit = $25.00 - $24.95 = $0.05 per ounce **Why other options are incorrect:** - **A**: There IS an arbitrage opportunity since the forward is overpriced - **B**: Selling spot and buying forward would result in a loss - **D**: Buying spot and buying forward doesn't create an arbitrage position The correct arbitrage strategy is to **buy silver in the spot market and enter into a 6-month forward contract to sell silver** (Option C).

Author: LeetQuiz .