CFA Practice Question

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CFA Practice Question

Consider a stock priced at $150, which will pay a dividend of $1.25 in 30 days, $1.25 in 120 days, and another $1.25 in 210 days. The risk-free rate is 5.25%. If you take a short position in a forward contract that expires in 250 days, what is the forward price if the contract is established today and expiring in 250 days?
A. $150
B. $149.74
C. $151.53
Explanation: First find the present value of the dividends: PV(D, 0, T) = PV(D, 0, 250/365) = 1.25/(1.0525)30/365 + 1.25/(1.0525)120/365 + 1.25/(1.0525)210/365 = $3.69.

Then find the forward price: F0(T) = F0(250/365) = (150 - 3.69) (1.0525) 250/365 = $151.53.

User Contributed Comments 3

User Comment
broadex Can some explain why we do not use 1+ (0.0525*120/365) when discounting interest rates instead of 1.0525^120/365

Sounds stupid but im consufed.
rjdelong Yes great question, this is a stock. The exponent method is used for stocks, and I believe other instruments other than bonds. For bonds, the convention is simple interest (the multiplication rule you showed).
sumeetb What you showed above @broadex is used only with LIBOR rates, otherwise use continuous compounding
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