Answer to Question #252396 in Finance for Kim

Question

Consider a 6-months futures contract on gold. We assume no income and that $1 per ounce per 6-months to store gold, with the payment being made at the end of the period. The spot price is $1620 and risk free rate is 2% for all maturities. How can an arbitrageur earn profit is the price of 6-month gold futures is 1630$?

Answer 1

The current market price at which a specific asset, such as commodities, securities or currencies ,can be bought or sold for immediate delivery is known as the spot price. A future price is an agreed upon price for the asset's future delivery.

FV of cost of buying 1 ounce of gold in spot and storing it for 6 months= SO$\times e^{rt}+1$

$=1620e^{0.02\times 0.5}+1$

=1637.28 (Gold future rate)

Hence, arbitrage profit can be made by;

1. Short the gold in the spot market.
2. Invest the proceeds at a risk-free rate for 6 months.
3. Enter into 6 months future contract to buy gold at forward rate.