Important information about Price of a Forward Contract
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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?
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Solution Summary
The solution calculates the price of a forward contract for different spot interest rates.
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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
(^ ...
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