Using prices reported above, identify & explain whether or not this(by definition) is a ‘normal’ futures market.

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On separate sheets of paper, please provide discussion and your supporting calculations to answer the word problems below. All work is to be done individually, and full credit can only be awarded if all calculation work is fully shown in solutions.

With Greece’s bailout strategy & timing still in doubt, FOREIGN EXCHANGE MARKETS are roiling and over-reacting

veritably each and every day. As assistant currency arbtrader for CountriCorp, you notice the following “spot

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vs. futures”FX imbalance pop up on Country’s trading screens market-open on Monday morning early March ‘18:

Spot Japanese Yen (¥ per $)            76.785

July 2018 Yen Futures                 .011809

(LIFFE delivers 12.5M ¥ in 124 days)

‘overnight’ term repo rate             1.07%


Countercoup has ongoing stockpiles of spot yen, whereby you’ve pre-approved access for (up to) 100 million yen

of internal ‘drawdown’ (borrowing) for arbitrage trading and profit-taking purposes. In addition to availability

of physical FX for buying/selling (and short-selling as needed), Country owns LIFFE seats and full access to the repurchase agreement market at term rates quoted above.

a. Using prices reported above, identify & explain whether or not this(by definition) is a ‘normal’ futures market.

Use your evaluation of price differences(basis) and any price trends to support your claims. As a result of your assessment, would forward or reverse C&C be profitable? (FULLY DESCRIBE conditions)

b. Disregarding all market frictions (such as transactions costs, short sale proceeds restrictions, or any other expenses and limitations/hindrances to storage and delivery); clearly outline and explain all necessary TRADES, resulting costs, revenues and profits for a

SIX(6) contract arbitrage of the strategy you proposed In part (a). Be explicit and complete in describing all Arb steps, particularly with the unwinding process. SHOW ALL WORK in determining this “academic” arb π.

c. Now consider any and all relevant arbitrage costs, calculate what profits are actually available to your firm net of ‘frictions’ and other restrictions. Suppose Countricorp faces .39% commissions onTRADED FUTURES contracts, a 1.68% spot market transactions cost, as well as a .3¢ per yen per month storage and delivery charge. Also, 20% of short sale proceeds are restricted. What’s ‘economic’ arb profit? SHOW INTERMEDIATE #s!

d. Using the Cost of Carrying pricing equation (including the market frictions), determine the yen futures price ‘at full carry’. What will happen to the size of the basis?


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