Question

Now suppose Stock A is dividend-paying, with $1 dividend paid for each 3 months. The spot price of a Stock A is $5, and the risk-free rate of interest is 8% per annum with continuous compounding. (d) What are the main differences between forwards and futures? (e) What are the forward price and the initial value of a one-year forward contract on one share of Stock A? (f) Four months later, the price of the stock is $6 and the risk-free interest rate is still 8%. What are the forward price and the value of the forward contract?

Answer 1

a. The primary difference between forwards and futures is that forwards can be traded on OTC (over-the-counter) markets while futures can be traded on exchanges.

b. The one-year forward contract's price will be calculated as = 5 x exp(0.08) + 1 x exp(0.08 x 9/12) + 1 x exp(0.08 x 6/12) + 1 x exp(0.08 x 3/12) + 1 x exp(0.08 x 0/12) = 9.5392

The forward price after 4 months will be = 6 x exp(0.08 x 8/12) + 1 x exp(0.08 x 6/12) + 1 x exp(0.08 x 3/12) + 1 x exp(0.08 x 0/12) = 9.3896