What Should a Trader Do When the One-Year Forward Price

question 12

Multiple Choice

What should a trader do when the one-year forward price of an asset is too low? Assume that the asset provides no income.

• A) The trader should borrow the price of the asset, buy one unit of the asset and enter into a short forward contract to sell the asset in one year.
• B) The trader should borrow the price of the asset, buy one unit of the asset and enter into a long forward contract to buy the asset in one year.
• C) The trader should short the asset, invest the proceeds of the short sale at the risk-free rate, enter into a short forward contract to sell the asset in one year
• D) The trader should short the asset, invest the proceeds of the short sale at the risk-free rate, enter into a long forward contract to buy the asset in one year

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Definitions:

Engel Curve

An Engel curve depicts the relationship between an individual's income and the quantity of a good purchased, illustrating how spending on the good varies with changes in income.

Demand Curve

graphically represents the relationship between the price of a good and the quantity of that good that buyers are willing to purchase at various prices.

Price Elasticity

A measure of how much the quantity demanded of a good responds to a change in the price of that good, defined as the percentage change in quantity demanded divided by the percentage change in price.

Total Expenditures

The sum total of all spending, often referenced in the context of consumer, government, or business expenditures.