Any suggestions on how to go about solving question II and III?
I went about finding the forward price of a futures contract drawn at time 0 and a futures contract drawn at time 4. I then subtracted the two to find the value of the futures contract drawn at 0 at time 9 and discounted it back to time 4 to obtain the value at time 4....however, the answer does not do that...can you explain how to solve this?
Also, I am clueless on how to solve part (iii). Can you guide me here?
Regards,
Sunil
(i) Explain what is meant by the “no arbitrage” assumption in financial
mathematics. [2]
An investor entered into a long forward contract for a security four years ago and the
contract is due to mature in five years’ time. The price of the security was £7.20 four
years ago and is now £10.45. The risk-free rate of interest can be assumed to be 2.5%
per annum effective throughout the nine-year period.
(ii) Calculate, assuming no arbitrage, the value of the contract now if the security
will pay dividends of £1.20 annually in arrear until maturity of the contract.
[3]
(iii) Calculate, assuming no arbitrage, the value of the contract now if the security
has paid and will continue to pay annually in arrear a dividend equal to 3% of
the market price of the security at the time of payment. [3]
[Total 8]
I went about finding the forward price of a futures contract drawn at time 0 and a futures contract drawn at time 4. I then subtracted the two to find the value of the futures contract drawn at 0 at time 9 and discounted it back to time 4 to obtain the value at time 4....however, the answer does not do that...can you explain how to solve this?
Also, I am clueless on how to solve part (iii). Can you guide me here?
Regards,
Sunil
(i) Explain what is meant by the “no arbitrage” assumption in financial
mathematics. [2]
An investor entered into a long forward contract for a security four years ago and the
contract is due to mature in five years’ time. The price of the security was £7.20 four
years ago and is now £10.45. The risk-free rate of interest can be assumed to be 2.5%
per annum effective throughout the nine-year period.
(ii) Calculate, assuming no arbitrage, the value of the contract now if the security
will pay dividends of £1.20 annually in arrear until maturity of the contract.
[3]
(iii) Calculate, assuming no arbitrage, the value of the contract now if the security
has paid and will continue to pay annually in arrear a dividend equal to 3% of
the market price of the security at the time of payment. [3]
[Total 8]