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1. This is a problem that has FOUR questions. Therefore, please choose FOUR answers (one choice for each question) to get full credit for this questions, otherwise you will only get partial points.

   The spot price of an investment asset is $25 and the risk-free rate is 8%, 8.5% and 9.5% for one-year-, two-year- and three-year-maturity, respectively. The asset provides an income of $4 at the end of the first year and at the end of the second year.

   *Note: all interest rates are quoted with continuous compounding in this problem

   #1) What should be the three-year forward price for no arbitrage opportunity?

   #2) What is the initial value of this forward contract?

   #3) If the 3-year forward price in the market is quoted as $21, what arbitrage opportunities does this create?

   #4) How much of the arbitrage profit is realized?

   		#1) theoretical forward price = $35.84
   		#1) theoretical forward price = $20.84
   		#1) theoretical forward price = $23.85
   		#1) theoretical forward price = $29.85
   		#2) initial value = $0
   		#2) initial value = not identifiable
   		#2) initial value = -$21.21
   		#2) initial value = +$21.21
   		#3) short forward contract, and buy the underlying asset in the spot market & borrow $25 at risk-free rate borrow PV of $4 at 8% for 1year borrow PV of $4 at 8.5% for 2year s borrow the remainder ($17.93) at 9.5% for 3years
   		#3) long forward contract, and buy the underlying asset in the spot market & borrow $25 at risk-free rate borrow PV of $4 at 8% for 1year borrow PV of $4 at 8.5% for 2year s borrow the remainder ($17.93) at 9.5% for 3years
   		#3) short forward contract, and short the underlying asset in the spot market & invest $25 at risk-free rate invest PV of $4 at 8% for 1year invest PV of $4 at 8.5% for 2year s invest the remainder ($17.93) at 9.5% for 3years
   		#3) long forward contract, and short the underlying asset in the spot market & invest $25 at risk-free rate invest PV of $4 at 8% for 1year invest PV of $4 at 8.5% for 2year s invest the remainder ($17.93) at 9.5% for 3years
   		#4) arbitrage profit = $3.54 in year 3
   		#4) arbitrage profit = $2.85 in year 3
   		#4) arbitrage profit = $4.85 in year 3
   		#4) arbitrage profit = $1.54 in year 3

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