### CFA Practice Question

There are 410 practice questions for this study session.

### CFA Practice Question

You can enter a derivative contract that will pay \$100 at the end of a year if the price of corn exceeds \$3 per bushel, or \$50 if it is equal to \$3 per bushel or lower. The probability that corn will exceed \$3 by the end of one year is 50%. The current price of the contract is \$60, and interest is 5% per year. What is the optimal strategy?
A. Buy \$3 per bushel worth of corn futures
B. Enter into the derivative contract for a cost of \$60
C. Invest \$60 at 5% until the end of the year
Explanation: Enter into the derivative contract for a cost of \$60, for the expected payoff is 0.50 * \$100 + 0.50 * \$50 = \$75. That is a 25% return on your investment in one year, greater than the 5% that could be made by investing the \$60 at interest. This is an example of the investment consequences of inconsistent probabilities. The present value of the contract should be \$75/1.05 = \$71.43. Thus, an arbitrage opportunity is present. On an expected value basis, you can buy an asset worth \$71.43 for only \$60.