Question

As of January 1, the price of a stock is $175. A dividend payment of $4.5 is made on each of May 1, July 1, and November 1. Let the risk-free continuously compounded interest rate be 3.5%. Kate believes the price of the stock is going to increase, and, therefore, she takes a long position in a one-year forward contract on the stock.

a) Find the forward price of the stock for delivery in one year: $_____ .

b) On June 1, the stock price has risen to $240. What is the current fair value of the forward contract initiated on January 1? $______

c) On June 1, Kate feels that now is the time to cash out. Explain how she can use a second forward contract (issued on June 1) to lock in a risk-free profit.
On June 1, Kate should enter a (long or short) (6-month or 7-month or 12-month) forward contract with a delivery price of $ _________ .

The risk-free profit realized on January 1 next year is $__________ .

d) In fact, Kate did not enter a second forward on June 1. On September 1, the stock price has fallen to $115. She is now concerned that the stock price would keep falling. Explain how she can use a second forward contract (issued on September 1) to lock in her loss.
On September 1, Kate should enter a        (long or short) (4-month or 6-month or 12-month)   forward contract with a delivery price of $_________ . The loss realized on January 1 next year is $___________ .

Note: Round any dollar values to the closest cent at every intermediate step.

Answer 1