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Question: An investor has just taken a short position in a one-year forward contract on a dividend paying stock. The stock is expected to pay a dividend of $2 per share in five months and in eleven months.
The stock price is currently selling for $100 and the risk-free rate of interest is 8.50% per year with continuous compounding for all maturities.
a. What are the forward price and the initial value of the forward contract? The forward price is [x] (sample answer: $75.50) and the initial value is [y] (sample answer: $75.50)
b. Six months later, the price of the stock is $105 and the risk-free rate stays the same. What are the forward price and the value of the position in the forward contract? Now the forward price is [z] (sample answer: $75.50) and the position value is [s] (sample answer: +$5.50; or -$5.50)
Verified Expert
The assignment was based on the investment done by an investor who requested for dividend pay back and it's forward price.The contract was done on the initial price which also required the position value.In this regard it involved calculations of forward prices,initial prices, position value and investors dividend.
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