Explore BrainMass

Explore BrainMass

    Important information about Price of a Forward Contract

    This content was COPIED from BrainMass.com - View the original, and get the already-completed solution here!

    You enter into a forward contract to buy a 10-year, zero coupon bond that will be issued in one year. The face value of the bond is $1,000, and the 1-year and 11-year spot interest rates are 3 percent per annum and 8 percent per annum, respectively. Both of these interest rates are expressed as effective annual yields.

    a. What is the forward price of your contract?

    b. Suppose both the 1-year and 11-year spot rates unexpectedly shift downward by 2 percent. What is the price of a forward contract otherwise identical to yours?

    © BrainMass Inc. brainmass.com June 3, 2020, 6:05 pm ad1c9bdddf
    https://brainmass.com/business/business-math/important-information-about-price-of-a-forward-contract-46874

    Solution Preview

    A. What is the forward price of the contract?

    We first need to calculate the 10 year interest rate at the end of year 1

    1 year spot interest rate= 3%
    11 year spot interest rate= 8%

    Therefore 10 year spot interest rate at the end of year 1= 8.51% ={(1+8%)^11/(1+3%)}^(1/10)-1
    (^ ...

    Solution Summary

    The solution calculates the price of a forward contract for different spot interest rates.

    $2.19

    ADVERTISEMENT