Skip to content

FRM Part I · FRM Exam Part I · Pricing Financial Forwards and Futures

Under the cost-of-carry model, a forward on an asset with no income or storage costs trades at a price above S0 e^(rT). Which action captures an arbitrage profit?

Borrow to buy the asset and sell the forward. When the forward exceeds S0 e^(rT), delivering the asset at the high forward price more than repays the loan with interest, locking in a riskless profit.

  1. ABuy the asset with borrowed money and sell the forwardCorrect
  2. BShort the asset, invest proceeds, and buy the forward
  3. CBuy the forward and buy the asset
  4. DSell the forward and lend money without buying the asset

Explanation

If the forward is overpriced relative to S0 e^(rT), borrow at r to buy the asset and short the forward. At maturity deliver the asset, receive F, and repay S0 e^(rT), leaving a riskless profit. The reverse strategy applies when the forward is underpriced.

Did you get it right without looking?

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

Practise Pricing Financial Forwards and FuturesFree diagnostic mock

More Pricing Financial Forwards and Futures questions