An investment bank engages in stock index arbitrage for its own and customer acc

Question

An investment bank engages in stock index arbitrage for its own and customer accounts. On a particular day, the S&P index at the New York Stock Exchange is 602.25 when the futures contract for delivery in 90 days is 614.75. If the annualized 90-day interest rate is 8.00 percent and the (annualized) dividend yield is 3 percent, would program trading involving stock index arbitrage possibly take place? If so, describe the transactions that should be undertaken and calculate the profit that would be made per each “share” of the S&P 500 index used in the trade.

Explanation / Answer

Interest rate =8% p.a.

Dividend yeild = 3% p.a.

Interest rate net of Dividend yeild=8-3=5%p.a

90 day net interest on $602.25 @5% p.a. = 602.25*5%*90/365 = $7.43

Total cost for buying one S&P index including interest for 90 days =602.25+7.43 =609.68

The same index can be delivered at $614.75. So gain=614.75-609.68 = $5.08

Arbitrage is possible and profit from such transaction = $5.08

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.