(b) The current price of Stock X is $25. The stock pays no dividends. A zero-coupon...

 

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(b) The current price of Stock X is $25. The stock pays no dividends. A zero-coupon default-free government bond with a face value of $100 and one year to maturity is trading at $98. You are offered a forward price for Stock X to be delivered in one year at $24.50. Comment on the validity of the following statement: "The forward price is lower than the spot price because the market anticipates a sharp decline in the price of Stock X, and the contract offers a way to hedge this risk. There is no arbitrage opportunity." (If you believe that there is an arbitrage opportunity, specify the arbitrage strategy). [6 marks] (b) The current price of Stock X is $25. The stock pays no dividends. A zero-coupon default-free government bond with a face value of $100 and one year to maturity is trading at $98. You are offered a forward price for Stock X to be delivered in one year at $24.50. Comment on the validity of the following statement: "The forward price is lower than the spot price because the market anticipates a sharp decline in the price of Stock X, and the contract offers a way to hedge this risk. There is no arbitrage opportunity." (If you believe that there is an arbitrage opportunity, specify the arbitrage strategy). [6 marks]

Answer rating: 100% (QA)

To evaluate the validity of the statement lets consider the relationship between the spot price forw... View the full answer