(5 points) Suppose the price of a non-dividend stock is $1,000 and the risk-free
ID: 2811438 • Letter: #
Question
(5 points) Suppose the price of a non-dividend stock is $1,000 and the risk-free rate is 8% continuously compounded. There is a $25 transaction fee when buying/selling stock and $25 transaction fee when going long or short a forward contract. With transactions costs there is no longer a single no-arbitrage price for the forward contract, but instead a range of prices. What is the no-arbitrage range (i.e., minimum and maximum) for a one-year forward contract given the transactions costs? Note, there is no transaction fee for making or taking delivery under the forward contract 5.Explanation / Answer
The forward price,fo, is given by equation f0=Se^rt, where s =$1000, r =8% i.e .08 , t=1 yr
1000e^(.08*1)=1083.287
value of the delievery price k= $25
the value of long forard contract f= (f0-k)e^rt
=(1083.287-25)e^.08*1=1146.429
the range is $1083.287 to $1146.429
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