Question

A one-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?

Answer 1

Answer:

The correct solution is:

(a) $44.21

(b) $47.30

Explanation:

(a)

According to the question,

Stock price,

S = $40

Risk free rate,

r = 10%

 = 0.10

Delivery rate,

t = 1

Mathematical constant,

e = 2.72

Now,

The forward price will be:

⇒ $F= S\times e^{(r\times t)}$

On substituting the estimated values, we get

⇒     $=40\times 2.72^{(0.10\times 1)}$

⇒     $=44.21$ ($)

(b)

6 months later,

The forward price will be:

⇒ $F= S\times e^{(r\times t)}$

⇒     $=45\times 2.72^{(0.10\times 1)}$

⇒     $=47.30$ ($)

The initial value becomes assumed to be zero (0) since forward contracts constitute procurement deals which really determine the exchanging of a particular property though on a fixed period although at a price that has been accepted today.