CFA Practice Question

There are 206 practice questions for this study session.

CFA Practice Question

The price of a stock is $65 now. A forward contract on the stock that expires in 6 months is currently priced at $70. The annual risk-free rate is 4.35%. Suppose the stock does not pay any dividend within the next 6 months. If you enter into such a forward contract with a dealer to sell the stock in 6 months at $70 ______
A. no money changes hands.
B. you should pay the dealer $3.53.
C. the dealer should pay you $3.53.
Explanation: S0 = $65
F(0, T) = $70
T = 0.5
V0(0, T) = 65 - 70/1.04350.5 = -$3.53.

Because the contract is negative, the payment is made by the short to the long. In fact, this is an off-market forward contract.

User Contributed Comments 13

User Comment
bmeisner The question's saying that you have to pay the dealer to make the transaction have 0 value today. The question leads you to believe that the forward is being mispriced which is why I would expect the value to be paid to us. After all, we could borrow money to buy the stock and sell the future today.
HenryQ This is an off-market contract...
dblueroom I hear you bmeisner. I did the same thing naturally.
malawyer is my calculator broken? I get -4.89 out of the proposed calc?
malawyer oh, all rightie, just had to fix the "priority of transactions" on my calc, sorry for the comment ;-)

still, the valu for the long is -3,53 so why should he pay 3,53 to get -3,53? would be an immediate loss of 7,06
rhardin Why does money change hands? Just because it is a contract with a dealer? How do I know if it is off-market?
rana1970 If I sell at $70, I will receive $70 in 6 months. I have stock whose value is $65 now and will be 65(1+0.0435)=67.83 in 6 months. I will profit. Where am I wrong? Comment, please
jpowers You are short the contract, since you entered it to sell the stock, not buy it.
mtsimone Yes, you're going to sell. So the dealer isn't going to want to buy at the higher price... he'll expect to be compensated for the difference.
nmech1984 Am I missing something? Why money changes hands? How do we know that it is an off-market contract?
nmech1984 Assuming that the reason is that the initial contract difference is not zero?
eduardodre Malawyer, got the same -4,89. What am i doing wrong (hp12c here)?
eduardodre got it! thanks
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