A one-year oil futures contract is selling for $74.50. Spot oil prices are $68 and the one-year risk free rate is 3.25%. Taking into account the one-year oil futures price and the arbitrage profit implied, which of the following set of transactions will yield positive riskless arbitrage profits?

Question

Quizplus · Accepted Answer

To determine if there is an arbitrage opportunity, we need to calculate the theoretical futures price using the spot price, risk-free rate, and storage costs. If the actual futures price is greater than the theoretical futures price, then we have a situation for profitable arbitrage.
The theoretical futures price is calculated as follows:
F = S * e^(r*t)
Where F is the theoretical futures price, S is the spot price, r is the risk-free rate, and t is the time to expiration.
In this case:
F = $68 * e^(0.0325*1)
F = $70.36
Since the actual futures price of $74.50 is greater than the theoretical price of $70.36, there is an arbitrage opportunity.
Option A involves buying oil in the spot market with borrowed money and selling the futures contract. This strategy will yield profits because the investor can borrow money at a lower interest rate than the return from the futures contract. By selling the futures contract at $74.50 and buying the spot oil for $68, the investor can earn a riskless profit of $6.50 per barrel. Therefore, option A is the best choice for profitable arbitrage.

A One-Year Oil Futures Contract Is Selling for $74