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To design an arbitrage transaction using the given forward contract, follow these steps: Borrow 40...

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Finance

To design an arbitrage transaction using the given forward contract, follow these steps: Borrow 40 at the risk-free rate (4% per annum) for 6 months. Buy one Sigma stock at the current market price of 40. Enter into the forward contract to sell the Sigma stock in 6 months for 45. Cash Flows and Steps: Initial Investment: Borrow 40: You receive 40. Buy Sigma stock: You spend 40. Net cash flow at time 0: 0(since the borrowed amount is used to buy the stock). At Maturity (6 months later): Repay the loan: The amount to re Explanation: Arbitrage Opportunity: The forward price of 45 is higher than the future value of the current stock price (40) compounded at the risk-free rate (which would be 40.80). This discrepancy allows for a risk-free

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