Question 5 (20 points) There are two borrowing choices offered by the bank: 1. borrowing...
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Question 5 (20 points) There are two borrowing choices offered by the bank: 1. borrowing cash at 10.5% per annum, annual compounding; 2. borrowing gold at 2% per annum, annual compounding. (If gold is borrowed, interest must be repaid in gold. Thus, 100 ounces borrowed today would require 102 ounces to be repaid in one year.) Suppose that the price of gold now is $550 per ounce and forward contracts are fairly priced. The risk-free interest rate is 9.25% per annum, and storage costs of gold are 0.5% per annum, both with continuous compounding. a. Between these two choices of borrowing, which borrowing interest rate is too high in relation to the other? (12 marks) b. What is the borrowing interest for gold to be equivalent to the 10.5% interest rate for cash? (8 marks)
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