The spot price trades at a bid/ask quote of 100-101 (you can buy at 101 and sell at 100). The one-year forward trades at 99-101.90 (you can buy forward at 101.90 and sell forward at 99). If the simple interest rate for one year is 2%, which of the following statements is most accurate?
A) You can execute an arbitrage by buying spot and selling forward.
B) You can execute an arbitrage by selling spot and buying forward.
C) You can execute an arbitrage by selling spot, buying forward, and investing the proceeds of the spot sale at 2%.
D) You cannot execute an arbitrage at these prices.

Question

Quizplus · Accepted Answer

C) You can execute an arbitrage by selling spot, buying forward, and investing the proceeds of the spot sale at 2%. Selling the spot at 100 and buying forward at 101.90 would initially seem like a loss. However, if you invest the 100 from the spot sale at a 2% simple interest rate for one year, you will have 102 at the end of the year. This means you can cover the 101.90 forward purchase and have a small profit, without any net investment.

The Spot Price Trades at a Bid/ask Quote of 100-101