Question #99 - Reading 31 Valuation of Contingent Claims

Reading: Reading 31 Valuation of Contingent Claims

PDF File: Reading 31 Valuation of Contingent Claims.pdf

Page: 47

Status: Unattempted

Correct Answer: A

Shared Context

- An equity swap to hedge the equity risk for Gier would result in a net return on the portfolio of a: A) fixed rate of 4.5% for the year. B) variable rate based on the total return of QJX stock. C) fixed rate of 1.5% per quarter.

Question

Based on the futures information, an arbitrage opportunity can be exploited by:

Answer Choices:

A. buying the stock QJX, and selling the futures

B. buying the futures and buying the stock QJX

C. selling the stock QJX and buying the futures

Explanation

The calculated fair value of the futures contract is $100 ×(1+0.05)0.75 = $103.73. The asset is relatively underpriced and the futures contract is overpriced. By buying the stock and selling the futures we can lock in a profit greater than the risk-free rate with no risk.

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