At t₀:

- Tesla is trading @ $80; Google is trading @ $101

- 1-year risk free rate is 5%; the 2-year risk free rate is 10%.

- Tesla is going to pay a dividend at t1, but we do not know the dividend.

- Forward price on a 2-year Tesla forward contract is 82.

- Google is going to pay a dividend at t1, but the dividend is unknown.

- The forward price on a 2-year forward contract on Google is 121.

$0 is the cost of a dividend swap at t0, and makes a single payment at t1 of (Tesla Div1 - Google Div1 - SW) if you are long the swap, or - (Tesla Div1 - Google Div1 - SW) if you are short the swap, where SW is the dividend swap price determined at t0.

a)What is SW if there is no arbitrage?

b)If SW is $0.20 greater than in part a. Describe the trades to construct an arbitrage.

Answer rating: 100% (QA)

a In the absence of arbitrage the dividend swap price SW must be such that the present value of the expected future cash flows from the swap is zero T... View the full answer