Chapter 17, Problem 3PS

Summary Introduction

(A)

Adequate Information:

Current price/spot price - $1200

Risk-free interest rate - 2%

Time period to maturity - 1 year

To Compute:

Price of Futures Contract

Introduction:

The price of the futures contract can be calculated usingSpot-Futures parity theorywhich states that if an asset purchased today and held until the maturity of the futures contract, the value of the future contract is equal to the current spot price adjusted for the variables such as interest rate, dividends, time to maturity etc. In simple mathematical equation:

Future price=Spot price X (1 + Risk free interest rate - dividend yield)^ time period in years

Summary Introduction

(B)

To design

Risk free return strategy to take advantage of future pricing of gold futures contract and compute profits on the strategy.

Introduction:

Risk free return strategy are option strategies where one can sell option on one side and buy option on the other side to get good return.

Given information:

Here spot price of gold futures contract is $1200 and the selling price is $1141. Also, the price of gold futures contract at maturity of 1 year will be $1224.

Explanation:

The spot price is $1200 and selling price is $1141 which means we can sale the gold at $1200 and at the same time buy the gold futures contract at $1141. After one year since the price of this gold futures contract will be $1224 so there will be profit on futures contract bought at$1141 which is ($1224-$1141) $83.

Therefore, the profit on risk free strategy of gold futures contract is $83.