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:

Beta

A measurement of the volatility of a stock or a portfolio in comparison to the market as a whole.

Discount Rate

The rate employed in discounted cash flow assessments to establish the current valuation of anticipated future cash flows.

Certainty Equivalent Approach

A method used in capital budgeting and investment theory that adjusts future cash flows to account for risk, making them equivalent in value to certain cash flows.

Risky Years

A term not widely recognized in finance; possibly refers to periods of high financial uncertainty or volatility.