Take the following situations: 1) Forward price > theoretical F.Price 2) Forward price < theoretical F. Price To make arbitrage profit would we: 1) Borrow money now and use to buy shares now - short one forward contract, locking in the higher forward price and pay back the amount borrowed. 2) Borrow money now and long a forward contract - sell the shares at the end of the contract and payback the amount borrowed for the contract Is this correct? If so, how much do we "borrow" in each case?
1) looks correct to me. This is the situation in April 2015 Q4(iii). Take a look at the Examiners solution to that, which explains the situation. You need to borrow enough money to buy the shares. 2) should really just be the reverse of 1). So you take a long position in the forward contract (to benefit from buying the shares at the low forward price available), but would borrow the shares now, sell them, and invest the proceeds in cash (ie short sell the shares).
