Solved Question: Assume you own a 2010 car currently worth $12,000

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Assume you own a 2010 car currently worth $12,000. You plan to sell it in 2 months and you anticipate the price of the car to depreciate further over the next 2 months. The discrete risk free rate is 3%.

A.    To hedge against a possible decline in price during next 2 months, please explain should you go Long or Short on a Forward contract?

B.     Calculate the “no-arbitrage” forward price on this contract (Fo).

C.     After 1 month, the car sells for $11,500, and you entered into the forward contract at the “no-arbitrage” forward price above. Calculate the gain or loss to your position at this arbitrary point of time, 1 month into the contract.

Instead, if you are an arbitrageur, and the dealer offers to enter into a forward contract at $12,200. Indicate how you can earn an arbitrage profit (without currently owning the car asset) and what is the Total Arbitrage Profit.


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