Hi All,
I have a question on Question 4 (ii) April 2007 paper, please see below the question and examiner's note.
By the formula: S0*（1+D)^[ - (T - t1) ], I get the number of years for current value of the forward price of a new contract is 12-5, hence 7 years. But I don't understand the one for old contract, after accumulating for 5 years, that is 95*(1.03^5), using the same formula as mentioned before, shouldn't it be 7 years as well? i.e. 95(1.02)^(-7) (1.03)^5, instead of 95(1.02)^(-12) (1.03)^5 in the answer?
Thank you very much!
Best regards,
Elise
An investor entered into a long forward contract for a security five years ago and the
contract is due to mature in seven years’ time. The price of the security was £95 five
years ago and is now £145. The risk-free rate of interest can be assumed to be 3% per
annum throughout the 12-year period.
Assuming no arbitrage, calculate the value of the contract now if:
(ii) The security has paid and will continue to pay annually in arrear a dividend of
2% per annum of the market price of the security at the time of payment. [3]
Answer:
(ii) The current value of the forward price of the old contract is:
95(1.02)^(-12) (1.03)^5= 86.8376
whereas the current value of the forward price of a new contract is:
145(1.02)^(-7)=126.2312
⇒ current value of old forward contract is:
126.23 - 86.84 = £39.39
