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    Questions With Solutions

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    Arshad Ullah
    The document contains 6 questions regarding the valuation of forward contracts. The solutions show how to calculate the forward price and value of long and short positions in forward contracts on non-dividend paying stocks and commodities using the relevant pricing formulas. Key inputs include the spot price, delivery price, risk-free rate, time to maturity, and expected dividends. The solutions demonstrate applying the concepts to value forward contracts at initiation and at a later date based on changes in the underlying stock price and risk-free rate.

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    Questions With Solutions

    Uploaded by

    Arshad Ullah
    187 views4 pages
    The document contains 6 questions regarding the valuation of forward contracts. The solutions show how to calculate the forward price and value of long and short positions in forward contracts on non-dividend paying stocks and commodities using the relevant pricing formulas. Key inputs include the spot price, delivery price, risk-free rate, time to maturity, and expected dividends. The solutions demonstrate applying the concepts to value forward contracts at initiation and at a later date based on changes in the underlying stock price and risk-free rate.

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    The document contains 6 questions regarding the valuation of forward contracts. The solutions show how to calculate the forward price and value of long and short positions in forward contracts on non-dividend paying stocks and commodities using the relevant pricing formulas. Key inputs include the spot price, delivery price, risk-free rate, time to maturity, and expected dividends. The solutions demonstrate applying the concepts to value forward contracts at initiation and at a later date based on changes in the underlying stock price and risk-free rate.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    187 views4 pages

    Questions With Solutions

    Uploaded by

    Arshad Ullah
    The document contains 6 questions regarding the valuation of forward contracts. The solutions show how to calculate the forward price and value of long and short positions in forward contracts on non-dividend paying stocks and commodities using the relevant pricing formulas. Key inputs include the spot price, delivery price, risk-free rate, time to maturity, and expected dividends. The solutions demonstrate applying the concepts to value forward contracts at initiation and at a later date based on changes in the underlying stock price and risk-free rate.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    of 4

    1. A long forward contract on a non-dividend-paying stock was entered into some time ago.

    It currently has 3 months to maturity. The risk-free rate of interest (with continuous
    compounding) is 10% per annum, the stock price is $65, and the delivery price is $70. Find
    the value of this contract.

    Solution:
    V = (F0 – K )e–rT or

    V = S – (Ke–rT)

    Using the 2nd formula,


    S = 65
    K = 70
    r = 0.1
    T = 3/12
    V = 65 – (70 x 2.71828–0.1*0.25)
    V = 65 – (68.27)
    V = -3.271

    2. Repeat question 1 by assuming you have a short position.

    Solution:
    V = (K – F0 )e–rT or
    V = (Ke–rT) – S

    This question will have the same answer as in problem # 1 but with a positive sign, i.e.
    V = 3.271 (because long’s loss is short’s profit, keeping all values constant)

    3. Consider a three month futures contract on copper. Suppose that it costs $3 per ounce per
    year to store gold, with the payment being made at the end of the year. Assume that the
    spot price is $450 and the risk-free rate is 7% per annum for all maturities. Find the price
    of this contract.
    Solution:
    F = (S + U)erT
    F = (450 + 0)e0.07*0.25
    U = 0, because storage cost has to be paid at the end of the year, whereas the contract
    will mature before the completion of the year.

    4. Suppose the spot price of an asset is $20. The risk-free rate of return is 4% (per annum).
    Time is 1 year. The futures price on this asset is $25. Find out if this is the correct price of
    this contract or not along with justification.

    Solution:

    F = S erT
    F = 20 e0.04*1
    F = 20.816

    Since the calculated price is not equal to $25, therefor $25 is not the correct price. The
    correct price of this contract should be $20.816

    5. A 1-year long forward contract on a non-dividend-paying stock is entered into when


    the stock price is $40 and the risk-free rate of interest is 10% per annum with continuous
    compounding.
    (a) What are the forward price and the initial value of the forward contract?
    (b) Six months later, the price of the stock is $45 and the risk-free interest rate is still
    10%. What are the forward price and the value of the forward contract?

    Solution:

    a) K = S erT
    K = 40 e0.1*1
    K = 44.2
    b) F = S erT
    F = 45 e0.1*0.5
    F = 47.30

    V = (F0 – K )e–rT (long position)


    V = (47.30 – 44.2) e–0.1*0.5

    6. A stock is expected to pay a dividend of $1 per share in 2 months and in 5 months. The
    stock price is $50, and the risk-free rate of interest is 8% per annum with continuous
    compounding for all maturities. An investor has just taken a short position in a 6-month
    forward contract on the stock.

    (a) What are the forward price and the initial value of the forward contract?

    (b) Three months later, the price of the stock is $48 and the risk-free rate of interest is
    still 8% per annum. What are the forward price and the value of the short position
    in the forward contract?

    Solution:

    a) K = (S – I) erT
    I = 1 e-0.08*0.167 + 1 e-0.08*0.416
    I = 0.987 + 0.968
    I = 1.955
    K = (50 – 1.955) e0.08*0.5
    K = 50.005

    b) F = (S – I) erT
    I = 1 e-0.08*0.167
    F = (S – I) e0.08*0.25
    V = (K – F0 )e–0.08*0.25 (short position)

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