Hi all, I have come across ‘Cash and Carry’ and 'cost of carry, these terms. Can somebody explain me why it is called ‘Cash and Carry’ and 'cost of carry arbitrage? Many thanks S
As an example, let’s take the ‘cash and carry’ arbitrage taking advantage of overpriced equity forward. To exploit the mispricing, you would sell the forward and simultaneously borrow cash to buy the underlying stock. You would then carry the underlying to forward maturity date, deliver it to counterparty, return the borrowed cash and keep whatever is left over. Your cost of carry would be the interest rate on the borrowed cash. Similar arbitrage opportunities might exist wherever the cost of carry is less/more than what the forward price implies. E.g., FX forwards (cost of carry is domestic interest rate minus foreign interest rate), equity forward prices (interest rate minus dividend yield), etc.