Arbitraging futures contract | Finance & Capital Markets | Khan Academy | Summary and Q&A

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March 21, 2011
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Khan Academy
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Arbitraging futures contract | Finance & Capital Markets | Khan Academy

TL;DR

By taking advantage of price discrepancies between current market prices and futures contracts, it is possible to make risk-free profits through arbitrage.

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Questions & Answers

Q: How can one make risk-free profits with futures contracts?

By borrowing money at a lower interest rate, buying a commodity at a lower market price, and selling a futures contract at a higher settlement price, it is possible to make a guaranteed profit.

Q: What are the key parameters for arbitrage opportunities in futures contracts?

The key parameters are the current market price, the settlement price, the cost of borrowing, and the difference between the market price and the settlement price.

Q: Can arbitrage be done with any commodity or only specific ones?

Arbitrage opportunities exist for commodities where the settlement price is higher than the cost of borrowing. It depends on the price difference and the interest rates.

Q: Are there any risks involved in arbitraging futures contracts?

In theory, if all parameters are correct, there should be no risks involved. However, there could be potential risks associated with margin requirements and unforeseen market fluctuations.

Summary & Key Takeaways

  • The current market settlement price for a Futures Contract for apples to be delivered in one year is $300, while the current market price today is $200.

  • By borrowing $200, buying 1,000 pounds of apples, and simultaneously selling the futures contract, it is possible to make a guaranteed risk-free profit of $80 in one year.

  • As long as the settlement price is higher than the cost of borrowing, there is always an opportunity for arbitrage.

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