# Cash and carry arbitrage - Reading 39

Hi, I am a bit confused by an end of chapter’s CFAI question in Reading 39. So far a cash and carry arbitrage for me was: - going long the commo - borrowing the amount necessary to purchase the commo - shorting the future contract - if any, pay your storage costs as you are long the commo This brings you to a potential return if there is mispricing. But the exercise number 2 page 187 question B treats the cash and carry arb differently, going long a forward Dec 04 and shorting a forward March 05. There is no reference either to going long the commo or borrowing the amount to purchase the commo. It starts to confuse me, as I was cruising through Schweser Qbank with an 85% and now I realize I miss the essential! Thanks in advance for the help. -N

Anybody?

Use Gold for commo and you will start seeing how it makes sense. Going long a future has similar exposure as buying the underlying commodity. The missing piece is need to borrow for the diff between long position and short position. Thats missing in the the text you cited.

Hi, I was also a little confused but I think the reasoning is as follows: The Ansa to 2B considers the Dec2004 forward price as a proxy for the spot price. So the commodity is actually purchased(Long) in Dec for the forward price = spot price of 3.000. If you work it you with the borrowing costs: (sorry formatting does not work- # separates columns) Time 0 # Time = 3/12 Short March FW # 3.075 -S(T) Buy Spot Dec -3.00 # S(T) Borrow Purchasing costs 3.00 # - 3.04534 Pay Storage Costs # -0.03 Total 0 # 0 There is no arbitrage. The transaction is well hedged which means you earn the risk free rate of return of 6%. The question asks for the annualized rate of return which would be what you spent at the beginning and what you earned at the end which happens to be the risk free rate of return. My reasoning: If you are calculating arbitrage profits, then consider the borrowing/lending costs. If calculating annualized rates of return, do not consider borrowing/Lending costs. GET SET GO would you agree?

aniri: I agree.