Hi,
I have another question - how do you calculate "Buy commodity", and "Short forward at F0" cash flows? I presume return of 10.305 on 9.9 is supposed to be 4% (rounding error, it is 4.1%)
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Hi,
Current spot price=10 =>Fo=10*exp(.03+.01-.02)=10.202 and E(St)=10*exp(.07+.01-.02)=10.618
If actual firward price=Fo=>short forward
For investor should buy, the future cash flow=10.618 as he holds asset which in pv terms is 10.618/exp(.07)=9.90 which shud be invested to get 10.618.we bought the asset by borrowing at .03 ,9.90 and need to pay back as 9.9*exp(.03)=10.202
Net cash for investor at expiration=short firward using the bought asset-pay loan=10.202-10.202=0.
In case Fo<FORWAARD price=> short forward at price 11 then net cash at expiration=11-10.202=.798
Thanks
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