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    Forward Contract

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    A stock is expected to pay a dividend of $2 per share in one month and again in four months. The stock price is $75 and the risk-free rate of interest is 7% per annum with continuous compounding for all maturities. An investor has just taken a short position in a six-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 $73 and the risk-free rate of interest is still 7% per annum. What are the forward price and the value of the short position in the forward contract?

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    Solution Preview

    Forward Prices
    A stock is expected to pay a dividend of $2 per share in one month and again in four months. The stock price is $75 and the risk-free rate of interest is 7% per annum with continuous compounding for all maturities. An investor has just taken a short position in a six-month forward contract on the stock.

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

    F = (S-I) e ^ (rt)
    (e is the exponential function)
    S= Spot price
    I= ...

    Solution Summary

    The solution:
    1) calculates the forward price and the initial value of the forward contract.
    2) calculates the forward price and the value of the short position in the forward contract three months later, when the price of the stock has changed.

    $2.19

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