Explain the carry arbitrage model both when the underlying generates cash flows and when it does not
The idea
A forward must equal the cost of buying the asset now and financing it to delivery. Without cash flows, F0 = S0 × (1 + r)^T. With cash flows, benefits are subtracted and costs added: F0 = (S0 − PV of benefits + PV of costs) × (1 + r)^T. If the quoted forward is above this, carry arbitrage: sell the forward, borrow, buy the asset and deliver it. If below, reverse carry: buy the forward, short the asset and lend. The profit at expiry is the gap between quoted and fair prices. The trap is ignoring the income, which overstates the fair price and can flip the direction of the trade.
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