Question

You have entered into a long forward contract on a dividend-paying stock some time ago, and this will expire in six months. It has a delivery price of $40 and the current stock price is $35. The stock provides a fixed dividend yield of 8% with semi-annual compounding. If the risk-free rate is 12% per annum with continuous compounding, what is the value of this long forward contract?
A. $6.72

B. -$4.02

C. $4.02

D. -$6.72

Answer 1

Answer:

correct option is B. -$4.02

Explanation:

given data

delivery price = $40

current stock price = $35

fixed dividend yield = 8% = 0.08

risk free rate = 12% = 0.12

solution

as we know that forward contract is a agreement that is made between 2 parties ( seller or buyer ) asset in future at today fix price in specified time,

we get here long forward contract value that is express as

long forward contract = $\frac{stock\ price}{(1+dividend\ rate)^t} -\frac{forward\ rate}{e^{r*t}}$    ...................1

put here value we get

long forward contract = $\frac{35}{(1+0.08)^{6/12}} -\frac{40}{e^{0.12*6/12}}$  

solve it we get

long forward contract = -$4.02

so correct option is B. -$4.02