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The one-year futures price on a particular stock index portfolio is $1,825, the stock index...

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Finance

The one-year futures price on a particular stock index portfolio is $1,825, the stock index is currently 1,800, the one-year risk-free interest rate is 3%, and the year-end dividend that will be paid on an $1,800 investment in the index portfolio is $25. a. By how much is the contract mispriced? b. Formulate a zero-net-investment arbitrage portfolio, and show how you can lock in riskless profits equal to the futures mispricing. c. Now assume that if you short-sell the stocks in the market index, the proceeds of the sale are kept with the broker and you do not receive any interest income on the funds. Is there still an arbitrage opportunity even though you do not own the shares in the index? How or why not? d. Given short-sale rules, what is the no-arbitrage band for the stock-futures price relationship? That is, given a stock index of 1,800, how high and how low can the futures price be without giving rise to arbitrage opportunities.

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