Is something wrong with the solution to question B on page 205, Curriculum Vol 5? I think the borrowing activity is left out in the table, which is an ingredient of the cash and carry arbitrage. There should be a borrowing of $3 at Time 0 to fund the buy order on the spot market. And a repayment of interest and principal totaling 3*exp (6%*0.25)=3.03135 at T= 3/12. In effect, the net cash flow at Time 0 is 0, and is 3.075-[3*exp(6%*0.25) + 0.03] = 0.01485 at Time = 3/12. As a result, the annualized rate of return for this cash and carry arbitrage should be (1+0.0485)^(12/3) -1 = 6.07%. Why not take the borrowing activities into account? Could anybody be so kind to point out what is wrong with my logic shown above? Thanks a bunch!

My curriculum does show borrowing of $300 at Time 0 at a rate of 5%.

really?

The op is talking about question 2 (the widgets) and not the question about gold (question 1). I am confused about this too. I think question 2 doesn’t have borrowing b/c it is asking for effective annual return and I’m guessing you don’t borrow in T0 b/c you gonna need a number for the denominator (your cost) when calculating the effective return. And if it is asking about arbitrage, borrow at T0 (which is what Q1 and Q3 is asking). Otherwise, how would you know when to borrow and when not to as Q1 has the borrowing in T0 and Q2 doesn’t.