- CFA Exams
- CFA Level I Exam
- Study Session 16. Derivatives
- Reading 49. Basics of Derivative Pricing and Valuation
- Subject 3. Pricing and Valuation of Forward Contracts
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.
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 |