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CMA Final · Strategic Financial Management · Forwards and Futures

Nifty spot is 22,000. A 3-month futures contract is quoted at 22,500. The risk-free rate is 8% p.a. (simple, annualised) and the index yields no dividend. Ignoring transaction costs, which action locks in an arbitrage profit and what is the profit per unit of index?

Buy the index at spot and sell the futures, earning 60 per unit. Fair futures value is 22,000 grossed up by 2% for three months, which is 22,440. The quoted 22,500 is 60 higher, so the overpriced futures should be sold against a financed spot purchase.

  1. ABuy spot, sell futures; profit 60Correct
  2. BSell spot, buy futures; profit 60
  3. CBuy spot, sell futures; profit 500
  4. DSell spot, buy futures; profit 440

Explanation

Fair futures = 22,000 x (1 + 0.08 x 3/12) = 22,000 x 1.02 = 22,440. Market futures at 22,500 is overpriced by 60, so buy spot, finance at the risk-free rate and sell futures. Profit of 500 ignores the financing cost of 440.

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