Question

A one-year long forward contract on a non-dividend-paying stock is entered into when the stock price...

A one-year long forward contract on a non-dividend-paying stock is entered into when the stock price is \$40 and the risk-free rate of interest is 10% per annum with continuous compounding.

a) What are the forward price and the initial value of the forward contract?

b) Six months later, the price of the stock is \$45 and the risk-free interest rate is still 10%. What

A one-year long forward contract on a non-dividend-paying stock is entered into when the stock price is \$40 and the risk-free rate of interest is 10% per annum with continuous compounding.

c). If actual forward contract price  in month 6 is \$46, formulate an arbitrage strategy.

a) Forward Price = Current Spot Price * e(risk-free rate of interest * delivery date in years)

Forward Price = \$40 * 2.7183(0.1*1) = \$40*1.105 = \$44.21

The initial value of the forward contract is \$0 as no money is exchanged in initial agreement of a forward contract.

b and c) Forward Price = Current Spot Price * e(risk-free rate of interest * delivery date in years)

Actual Forward Contract Price in month 6 is \$46 but it should be = \$45 * 2.7183(0.1*0.5) = \$47.31. So the actual forward contract price is less by \$1.31 Buy the forward now and expect to sell it at \$47.31 after 6 months.

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