Skip to content

NISM Certifications · NISM-Series-VIII: Equity Derivatives · Introduction to Forwards and Futures

Spot of a stock is Rs 200 and the 6-month futures trades at Rs 214. The risk-free rate is 8% per annum (simple, for this question), no dividends. Ignoring costs, which action yields a risk-free arbitrage profit and how much per share at expiry?

Futures are overpriced versus the fair value of Rs 208, so the trader buys the stock using borrowed funds and sells futures. At expiry the Rs 214 received less Rs 208 loan repayment gives a risk-free profit of Rs 6 per share.

  1. ABuy futures, sell spot; profit Rs 2
  2. BBuy spot with borrowed money and sell futures; profit Rs 6Correct
  3. CBuy spot with borrowed money and sell futures; profit Rs 14
  4. DNo arbitrage exists

Explanation

Fair value with simple interest = 200 x (1 + 0.08 x 0.5) = 208. Futures at 214 are overpriced, so buy spot (borrow Rs 200) and sell futures. At expiry deliver the stock for 214 and repay 208, a profit of Rs 6. Rs 14 ignores the financing cost.

Did you get it right without looking?

One question tells you little. A timed set on Introduction to Forwards and Futures shows your real accuracy, how long you take and where you lose marks.

Practise Introduction to Forwards and FuturesFree diagnostic mock

More Introduction to Forwards and Futures questions