Consider a stock that will pay a dividend of D dollars in one year, which is when

Question:

Consider a stock that will pay a dividend of D dollars in one year, which is when a futures contract matures. Consider the following strategy: Buy the stock, short a futures contract on the stock, and borrow S0 dollars, where S0 is the current price of the stock.

a. What are the cash flows now and in one year? (Remember the dividend the stock will pay.)

b. Show that the equilibrium futures price must be F0 = S0 (1 + r) - D to avoid arbitrage.

c. Call the dividend yield d = D / S0, and conclude that F0 = S0(1 + r - d )?

Dividend
A dividend is a distribution of a portion of company’s earnings, decided and managed by the company’s board of directors, and paid to the shareholders. Dividends are given on the shares. It is a token reward paid to the shareholders for their...