On January 21, gold is selling for $387.25 per oz. in the spot market while the future price for 3 month (90days) April gold is $402.50 per oz. on a 100 oz. contract. If the risk-free rate is 5.25% determine what profit an investor will realize if he/she uses arbitrage (cash-and-carry or reverse cash-and-carry) to exploit the situation. (Assume the investor use 2 gold future contracts, and that no carrying costs are involved for storage or insurance) Show all work.
NOTE: Walk through the steps employed in the process for carrying out cash-and-carry or reverse cash-and-carry arbitrage by calculating or stating clearly;
1) What the Future Price should be according to the cost-and-carry model
2) Which arbitrage process (cash-and-carry or reverse cash-and-carry) approach you would use?
3) How you would set up the arbitrage process you would use.
4) What the total profit from the arbitrage will be if you employ 2 contracts.