Question #38
Reading: Reading 30 Pricing and Valuation of Forward Commitments
PDF File: Reading 30 Pricing and Valuation of Forward Commitments.pdf
Page: 16
Status: Unattempted
Question
A stock is currently priced at $110 and will pay a $2 dividend in 85 days and is expected to pay a $2.20 dividend in 176 days. The no arbitrage price of a six-month (182-day) forward contract when the effective annual interest rate is 8% is closest to:
Answer Choices:
A. $110.00
B. $110.06
C. $110.20
Explanation
In the formulation below, the present value of the dividends is subtracted from the spot
price, and then the future value of this amount at the expiration date is calculated.
(110 – 2/1.0885/365 – 2.20/1.08176/365) 1.08182/365 = $110.06
Alternatively, the future value of the dividends could be subtracted from the future value
of the stock price based on the risk-free rate over the contract term.