CFA Practice Question

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CFA Practice Question

Consider a stock priced at \$65, which will pay a dividend of \$0.75 in 50 days and another \$0.75 in 100 days. The risk-free rate is 6.4%. If an investor decides to commit to a future purchase of the stock by going long a forward contract (which expires in 150 days) on the stock, at what price would the investor commit to purchase the stock in 150 days through a forward contract?

First find the present value of the dividends: PV(D, 0, T) = PV(D, 0, 150/365) = 0.75/(1.064)50/365 + 0.75/(1.064)100/365 = \$1.48.

Then find the forward price: F0(T) = F0(150/365) = (65 - 1.48) (1.064)150/365 = \$65.16.

User Comment
GeorgeC Alternatively find the FV of the stock = 65 x (1.064)^(150/365) = \$66.68 then subtract the future value of the dividends:
FV Dividend 1 = 0.75 x (1.064)^(100/365) = \$0.763
FV Dividend 2 = 0.75 x (1.064)^(50/365) = \$0.756
So: 66.68 - 0.763 - 0.756 = \$65.16
rhardin I used the CF function on my calculator to find the PV of the dividends, but I got \$1.463 as the PV instead of \$1.48. Is this just because of rounding?
swt326 How do you know that it is 365 and not 360?
jpowers 360 is used with LIBOR rates in FRAs. All others are 365.
czar 360 is FRA's & tbills
cfastudypl Thanks GeorgeC.
mzaheedihm would someone please explain why risk free rate is not adjusted for various period, like the last basic question?
dbedford Mzaheedihm because it's not compounding it just has two pay out periods. If it was compounding the. The Rf would have to be adjusted
ashish100 this one was easyyyy.. im abt to get jinxed on the next one tho. i'm ready
Sagarsan88 The bigger point to note here is...inspite of dividend the forward price is higher than spot. This is because...the rate or return expected is higher than the benefit of dividend in the period.