Question

A 9-month forward contract is issued on 1 March 2011 on a stock with a price of £9.56 per share at that date. Dividends of 20 pence per share are expected on both 1 April 2011 and 1 October 2011.

(a) Calculate the forward price, assuming a risk-free rate of interest of 3% per annum effective and no arbitrage.

(b) Explain why the expected price of the share in 9 months’ time is not needed to calculate the forward price.

Answer 1

	Forward price = (S-D)e^rt
		(9.56-0.20)e^0.03*9/12
		(9.65-0.20)e^0.0225
		9.45*1.022755
		9.665035
Price of forward contract would be pound 9.67 b) The expected price is the price we expect to have which is already a future price. To calculate the future price or forward price of a contract we need the current rate and the risk free rate, say if we invest this money in risk free rate what would our money be priced after receiving the interest which is time value of money same is applicable for forward contract.