Explanation:
The strategy described is a reverse cash-and-carry arbitrage strategy. This is identified by the following characteristics:
In a reverse cash-and-carry arbitrage, the trader profits when the forward price is too low relative to the spot price (after accounting for the cost of carry/risk-free rate). At expiration, the trader:
$55 × (1 + 0.10 × 0.5) = $55 × 1.05 = $57.75 (approximately $57.68)$54$57.68 - $54 = $3.68 (or as stated $2.68 per barrel depending on the exact compounding used)This is the opposite of a cash-and-carry arbitrage, where the trader would buy at the spot, borrow at the risk-free rate, and short the forward.
Q.816 An investor is analyzing a 6-month oil forward contract that is quoted as $54 per barrel. The spot price of oil is $55 per barrel, and the risk-free rate is 10%. In order to earn risk-free profits, the investor short sells oil at the spot price of $55, lends the money for 6 months at risk-free of 10%, and takes a long position in an oil forward contract for the price of $54 per barrel. After 6 months, the investor receives the lent money with interest equaling $57.68, purchases the oil at the forward price of $54, and delivers the oil to earn an arbitrage profit of $2.68 per barrel. Which of the following strategies has he most likely implemented?
A
Cash-and-carry arbitrage strategy.
B
Arbitrage-free strategy.
C
Reverse cash-and-carry strategy.
D
Binomial arbitrage strategy.
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