Suppose the stock does not pay dividends. Denote the dates for today and the expiration date are
Question:
Suppose the stock does not pay dividends. Denote the dates for today and the expiration date are 0 and T respectively. Denote the current spot price of the stock as S', the spot price at the expiration date is S(, and the forward price for time T settlement signed today is F',(.
Assume the risk-free interest rate is a known constant r.
Answer the following questions:
(a). What are the cash flows for buying a stock (and then hold it and sell it at T)? Show the cash flow tables. Show the payoff diagram.
(b). What is the replicating portfolio of buying a stock that consists of certain positions in forwards and risk-free bonds (or equivalently, risk-free borrowing or lending)? Show the cash flow tables. Show the payoff diagrams of your chosen positions of forwards and risk-free bonds respectively, and then show the payoff diagram of the replicating portfolio.
(c). What are the costs of the two strategies, respectively?
(d). Use the no-arbitrage principle to price the forward.
Fundamental Accounting Principles
ISBN: 978-0077862275
22nd edition
Authors: John Wild, Ken Shaw, Barbara Chiappetta