CFA Level I · CFA Level I Exam · Arbitrage, Replication, and the Cost of Carry in Pricing Derivatives
A non-dividend-paying stock trades at 80. The one-year risk-free rate is 5% (annual compounding). The one-year forward on the stock is quoted at 86. An arbitrageur borrows 80, buys the stock and sells the forward. The arbitrage profit at forward expiration is closest to:
The arbitrage profit is closest to 2.00. The fair forward price is 80 × 1.05 = 84, but the forward is sold at 86. Delivering the stock for 86 and repaying the loan of 84 leaves 2.00 risk-free.
- A0.00
- B2.00Correct
- C6.00
Explanation
No-arbitrage forward price = 80 × 1.05 = 84. Forward quoted at 86 is overpriced. At expiry, deliver the stock and receive 86, repay the loan of 84, profit = 2.00. The 6.00 ignores loan interest.
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