You are interested in a forward contract on a non-dividend paying stock for a purchase of...
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You are interested in a forward contract on a non-dividend paying stock for a purchase of the underlying stock in two years. The current stock price is 65. You know that the stock price will either go up by a factor of 1.15 or go down by a factor of 0.8 each year (i.e. u and d are constant). (a) Draw a two-period binomial tree where you show the price of the underlying at each node. (b) Assuming a risk-free rate of 3% p.a. (compounded annually), which forward price are you willing to agree on today? (c) Suppose the bank quotes you a forward price above the one that you calculated in part (b). Is there an arbitrage opportunity, and if so, how can you exploit it? You are interested in a forward contract on a non-dividend paying stock for a purchase of the underlying stock in two years. The current stock price is 65. You know that the stock price will either go up by a factor of 1.15 or go down by a factor of 0.8 each year (i.e. u and d are constant). (a) Draw a two-period binomial tree where you show the price of the underlying at each node. (b) Assuming a risk-free rate of 3% p.a. (compounded annually), which forward price are you willing to agree on today? (c) Suppose the bank quotes you a forward price above the one that you calculated in part (b). Is there an arbitrage opportunity, and if so, how can you exploit it?
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