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Digital Stock: Arbitrage Opportunity

Provide a short justification the following:

The current price of Digital stock is $44 a share. You are offered a forward price for Digital stock to be delivered in one year of $42. The forward price is lower than the spot price because the market anticipates a sharp decline in the price of Digital stock, and the contract offers a way to hedge this risk. There is no arbitrage opportunity.

Solution Preview

The statement is true.

(1) Any forward contract can be used as a mean to hedge future risks. In this particular case, one will be welling to purchase this future contract in speculation that the future stock price ...

Solution Summary

This response provides reasoning for why a forward price for Digital stock is lower.