Suppose you observe the following one-year interest rates, spot exchange rates and futures prices. Futures contracts are available on €10,000. How much risk-free arbitrage profit could you make on one contract at maturity from this mispricing? Bid Interest Rate S0($/€) $1.45 = €1.00 i$ 4% F360($/€) $1.47 = €1.00 i€ 3% A) $59.22 B) $53.10 C) $49.42 D) none of the options

The amount of risk-free arbitrage profit that one could you make on the contract will be A. $159.22.

From the complete question, it should be noted that when one exercises the future contract to exchange €10000, the amount that will be gotten will be:

= €10000 × 1.48

= €14800

Now, the amount to return with interest will be:

= €14077.67 × 1.04

= €14640.78

Now, the arbitrage profit will be:

= €14800 - €14640.78

= €159.22

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A) $59.22

Explanation:

The futures are the contracts that are set in present for settlement at some future date. These contracts can be tailor made or over the counter. Usually futures trade in OTC market with defined contract size. In the given question the contract size is for €10,000. The denomination in dollar will be :

For Bid price : €10,000 * $1.45 / € = 14,500

For Ask price : €10,000 * $1.47 / € = 14,700

The difference in the bid-ask is 200.

The arbitrator could benefit from this price difference.

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