a. Assume that the FTSE100 stock index level is 5000, and there is a futures contract on the index maturing one year from today. Index stocks will pay dividends over the life of the contract, and these dividends can be reinvested whenever they are received to provide a total cash flow equivalent to 200 index points at futures maturity. Assume also that you can costlessly short sell the index basket of stocks and you can borrow and lend any amount of money at an annual rate of 5%. Assume also that you can ignore marking to market cash flows. What is the price of this futures contract maturing in an year?
Suppose that the futures contract is trading at 5400. What trades would you make today and one year hence to arbitrage? What is your arbitrage profit?
Suppose that the futures contract is trading at 4900. What trades would you make today and one year hence to arbitrage? What is your arbitrage profit?