Question

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.

Answer #1

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.

A one-year long forward contract on a non-dividend-paying stock
is entered into when the stock price is $41 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 are the forward price
and the value of the forward contract?

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