Understanding Futures Contracts and Arbitrage

The video tutorial explains a scenario involving futures contracts for apples, where the settlement price matches the current market price. It assumes apples do not spoil and explores borrowing and shorting apples to make a risk-free profit. By borrowing apples, selling them, and entering a futures contract to buy them back at the same price, a net profit is achieved through interest. This strategy sets a lower bound on the futures contract price, affecting market demand and supply.

What is the assumed settlement price for 1,000 pounds of apples in one year?

• $300

• $250

• $200

• $150

What is the interest rate given to the lender of the apples?

• 1%

• 2%

• 3%

• 4%

How much net interest does the borrower earn from shorting the apples?

• 4%

• 5%

• 3%

• 2%

What is the first step in the strategy to make a risk-free profit?

• Buy apples in the market

• Borrow and sell apples

• Enter a futures contract

• Store apples for a year

What is the agreed price to buy apples in the futures contract?

• $210

• $200

• $190

• $180

How much total money does the borrower have after one year, including interest?

• $210

• $200

• $212

• $208

What is the net profit made by the borrower after fulfilling the futures contract?

• $8

• $7

• $6

• $9

What happens to the market price if risk-free profit opportunities are available?

• Price fluctuates randomly

• Price increases

• Price decreases

• Price remains the same

What effect does increased demand for futures contracts have on the market?

• Decreases supply

• Increases price

• Decreases price

• Increases supply

What is the role of arbitrage in the market?

• To decrease demand

• To increase volatility

• To create risk

• To stabilize prices