Q1. A one-year long forward contract on a non-dividend-paying stock is entered i

Question

Q1. A one-year long forward contract on a non-dividend-paying stock is entered into when the stock price is $56 and the risk-free rate (with continuous compounding is 8%. (1) What are the forward price and the initial value of the forward contract? (2) Five months later, the price of the stock is $60 and the risk-free rate is still 8%, what are the forward price and the value of the forward contract? Q2. A one-year short forward contract on a non-dividend-paying stock is entered into when the stock price is $56 and the risk-free rate (with continuous compounding) is 8%. (1) What are the forward price and the initial value of the forward contract? (2) Seven months later, the price of the stock is $50 and the risk-free rate is still 8%, what are the forward price and the value of the forward contract?

Explanation / Answer

Q1.

1, Forward price F0 = 56*e^(8%) = 60.66408 and the initial value of forward contract is zero.

2.The delivery price in the contract is $60.66408. The value of the contract, f, after five months is

f = 60 - 60.66408*e(-0.08*5/12) = $ 1.324725

and the forward price will be F = 60*e^(8%*7/12) = $62.86636

Q2.

1. Forward price F0 =  56*e^(8%) = 60.66408, and the initial value of contract is zero.

2. The delivery price in the contract is $60.66408. The value of the contract, f, after seven months is

f = ($60.66408 - 56)*e^(-8%*5/12) = $4.511173

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