ch. 5

-forward contract K = delivery Fo = forward price today

- __ is worth zero (except for bed-offer spread effects) when it is first negotiated -later it may have a positive or negative value - __ is the delivery price and __ is the forward price for a contract that would be negotiated today

short selling

-selling securities you do not own -your broker borrows the securities from another client and sells them in the market in the usual way

foreign currency Fo=Soe^(r-rf)T

-this is analogous to a security providing a yield -the yield is the foreign risk free interest rate -what is the formula?

a.

A 3-month forward contract to buy a zero coupon bond that will mature one year from now. The current bond price is $965. If the 3-month risk free rate of interest is 9% continuously compounded. What is the forward price F0? a. 986.96 b. 995.69 c. 903.56 d. 936.56 e. 1000.98

d.

A short forward contract that was negotiated some time ago will expire in three months and has a delivery price of $40. The current forward price for three-month forward contract is $42. The three month risk-free interest rate (with continuous compounding) is 8%. What is the value of the short forward contract? a.+$2.00 b.-$2.00 c.+$1.96 d.-$1.96

a.

An exchange rate is 0.7000 and the six-month domestic and foreign risk-free interest rates are 7% and 5% (both expressed with continuous compounding). What is the six-month forward rate? a. 0.7070 b. 0.7177 c. 0.7249 d. 0.6930

b.

An investor shorts 100 shares when the share price is $50 and closes out the position six months later when the share price is $43. The shares pay a dividend of $3 per share during the six months. How much does the investor gain? a. $1,000 b. $400 c. $700 d. $300

c.

The spot price of an asset is positively correlated with the market. Which of the following would you expect to be true? a. the forward price equals the expected future spot price b. the forward price is greater than the expected future spot price c. the forward price is less than the expected future spot price d. the forward price is sometimes greater and sometimes less than the expected future spot price

b.

The spot price of an investment asset is $30 and the risk-free rate for all maturities is 10% with continuous compounding. The asset provides an income of $2 at the end of the first year and at the end of the second year. What is the three-year forward price? a. $19.67 b. $35.84 c. $45.15 d. $40.50

a.

The spot price of an investment asset that provides no income is $30 and the risk-free rate for all maturities (with continuous compounding) is 10%. What is the three-year forward price? a. $40.50 b. $22.22 c. $33.00 d. $33.16

b.

a coupon bond is ____. a. an investment asset with no income b. an investment asset with known income c. an investment asset with known yield d. a consumption asset

investment assets

assets held by significant numbers of people purely for investment purposes (gold, silver, stocks, zero coupon bonds)

consumption assets

assets held primarily for consumption (copper, oil)

the futures price of a stock index is always less than the expected future value of the index. this follows the fact that the index has a positive systematic risk. k>r, or Fo<E(St)

is the futures price of a stock index greater than or less than the expected future value of the index? explain your answer.

gold (at least for some periods) k<r, or Fo>E(St)

negative systematic risk

k=r, Fo=E(St)

no systematic risk

stock indices k>r, or Fo<E(St)

positive systematic risk

(K-Fo)e^-rt

the value of a short forward contract is:

(Fo-K)e^-rt

the value, f, of a long forward contract is:

Fo=Soe^rt

this equation relates the forward price and the spot price for any investment asset that provides no income and has no storage costs (gold, silver, zero coupon bonds, stocks with no dividends)

Fo=(So-I)e^rt

this equation relates to the forward price and the spot price when an investment asset provides a known dollar income (bonds, corporate bonds)

Fo=Soe^(r-q)T

this equation relates to the forward price and the spot price when an investment asset provides a known yield

1. at some stage you must buy the securities so they can be replaced in the account of the client 2. you must pay dividends and other benefits the owner of the securities receives 3. there may be a small fee for borrowing the securities

what are the 3 conditions for short selling?

a. an investment asset is an asset held for investment by a significant number of people or companies b. a consumption asset is an asset that is nearly always held to be consumed (either directly or in some sort of manufacturing process) the forward/futures price can be determined from the spot price for an investment asset. in the case of a consumption asset, all that can be determined is an upper bound for the forward/futures price.

what is meant by a). an investment asset and b). a consumption asset. why is the distinction between investment and consumption assets important in the determination of forward and futures prices?

a. the risk free rate b. the excess of the risk-free rate over the dividend yield c. the risk free rate plus the storage cost d. the excess of the domestic risk-free rate over the foreign risk-free rate

what is the cost of carry for a). a non-dividend paying stock, b). a stock index, c). a commodity with storage costs, and d). a foreign currency?

d.

when the forward contract is first negotiated, what is the forward price Fo? a. uncertain (need more info to compute) b. So C. Soe^-rt d. K e. Ke^-rt

c.

which of the following is a consumption asset? a. the s&p 500 index b. the canadian dollar c. copper d. IBM stock