The S&P/ASX200 spot contract is at 4055 and has a dividend yield of 8% p.a.The risk-free rate is 7% and the SPI futures price is currently trading at 4058.Which of the following statements is part of an arbitrage strategy to profit from this information?

A) Buy the spot and sell the futures contract
B) Borrow the spot and borrow at the risk-free rate
C) Borrow the spot and sell the future contract
D) Repay the dividends and invest at the risk-free rate

Question

The S&P/ASX200 spot contract is at 4055 and has a dividend yield of 8% p.a.The risk-free rate is 7% and the SPI futures price is currently trading at 4058.Which of the following statements is part of an arbitrage strategy to profit from this information?

A) Buy the spot and sell the futures contract
B) Borrow the spot and borrow at the risk-free rate
C) Borrow the spot and sell the future contract
D) Repay the dividends and invest at the risk-free rate

Quizplus · Accepted Answer

Using the share index futures pricing contract gives a theoretical futures price of F = 4055e^(0.08^-^0.07)F1F1F1S1^F1F1F10^90/365 = 4065.01.Therefore,the current futures contract price of 4058 is too low.The correct arbitrage strategy is therefore to buy the futures (SPI futures)contract and short-sell the spot contract (S&P/ASX200).The short-selling of the spot contract would involve borrowing the spot contract,repaying the dividends and then investing at the risk-free rate.Example 15.7

The S&P/ASX200 Spot Contract Is at 4055 and Has a Dividend