CFA Practice Question

There are 227 practice questions for this study session.

CFA Practice Question

A security is currently trading at $97. It will pay a coupon of $5 in two months. No other payouts are expected in the next six months. Assume continuous compounding at 12%. What should the forward price be on the security for delivery in six months?
Correct Answer: $97.794

We have S0 = 97, and the PV of the holding benefit is 5 * e(-0.12 * (2/12)) = 4.9010. Thus, the forward price should be (97 - 4.9010) * e (0.12 * (6/12)) = 97.794.

User Contributed Comments 5

User Comment
rodney176 Not getting this one at all
Alena1989 The PV of the holding period should divide (not multiply!) the future coupon ($5) by the e to the power of compounding rate multiplied by the time to the coupon - as we bring the value of the future coupon to the present so we need to discount it.
myron @Alena1989: it is divide - notice the minus sign
mtsimone Draw a timeline with this stuff.

This is just moving money around using PV/FV of money principals. You can either CC the $97 for two 2 months, subtract the $5 and then compound result another 4 months...

Or you could compound the $97 for 6 months, compound the $5 for 4 months, then subtract compounded $5 from the compounded $97.

Same result.
mtsimone I just looked at their answer and this is a third way: Discount the $5 for 2 months, subtract that result from $97, and compound that 6 months.

If you draw a timeline you can see how many different ways you can do this.

For me the timeline clarifies everything but then I'm not as bright as some of the quant folks in these threads.
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