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B. B. Chakrabarti
Professor of Finance
B. B. Chakrabarti: bbc@iimcal.ac.in
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The time value for money has been ignored in these calculations.
The return = 33.3% per annum >> 10% cost of borrowing fund The arbitrageur should do this as much he can. Unfortunately this type of opportunity rarely arise in practice.
Even if this arises this does not sustain.
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K ST
The payoff from a long position in a forward contract on one unit of an asset = ST - K The payoff from a long position in a European put option = Max (K ST, 0) - P
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K ST
-C
ST
Combining the two positions, we gets a long call. The payoff from a long position in a European call option = Max (ST K, 0) - C
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A perfect hedge always succeeds in locking in the current spot price of an asset for a future transaction.
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If the minimum variance hedge ratio is calculated as 1.0, the hedge must be perfect.
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If there is no basis risk, the minimum variance hedge ratio is always 1.0.
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Spot Price Change Futures Price Change Spot Price Change Futures Price Change
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y i 2 .3 594; x i y i 2 .3 52
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2 .447 4 0.96 0.51 1 6 9 1 0 9 2 .3 594 1 .3 0 0.493 3 9 1 0 9 1 0 2 .3 52- 0.96 1 .3 0 (1 0 2 .447 4 0.96) (1 0 2 .3 594 1 .3 0) -
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What position should the fund manager take to eliminate all exposure to the market over the next two months?