FRM Part I · FRM Exam Part I · Pricing Financial Forwards and Futures
A 1-year forward on a bond is quoted when the bond's spot price is $950 and it will pay a coupon of $60 in 6 months. The continuously compounded risk-free rate is 4% for all maturities. Which forward price avoids arbitrage (nearest dollar)?
The arbitrage-free forward price is about $928. Deduct the present value of the $60 coupon from the $950 spot price, then compound at 4% for one year. Ignoring the coupon would wrongly give roughly $989.
- A$928Correct
- B$988
- C$950
- D$1,010
Explanation
PV of coupon = 60e^{-0.02} = 58.81. Adjusted spot = 950 − 58.81 = 891.19. F0 = 891.19 × e^{0.04} = 891.19 × 1.040811 = 927.56, about $928. $988 ignores the coupon. $1,010 adds the coupon.
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