You Specialize in Arbitrage Between the Futures and the Cash

question 18

Essay

You specialize in arbitrage between the futures and the cash market on the Paris Bourse. The CAC stock index is made up of 40 leading stocks. The futures price of the CAC contract with delivery in a month is 2,120. The size of the contract is €10 times the index. The spot value of the index is given as 2,000. Actually, there are transaction costs in the cash market; the bid-ask spread is around 40 points. You can buy a basket of stocks representing the index for 2,020 and sell the same basket for 1,980. Transaction costs on the futures contracts are assumed to be negligible. During the next month, the stocks in the index will pay dividends amounting to 5 per index. These dividends have already been announced, so there is no uncertainty about this cash flow. The current one-month interest rate in euros is 6¹/₂ -⁵/₈%.
a. Do you detect any arbitrage opportunity?
b. What profit could you make per contract?
c. What is the theoretical value of the futures bid and ask prices?

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