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CFA Level I · CFA Level I Exam · Pricing and Valuation of Forward Contracts and for an Underlying with Varying Maturities

A forward contract on a dividend-paying stock was initiated at a fair forward price. Shortly afterward, the market announces an unexpected increase in the dividend to be paid before contract expiration, with the spot price and interest rates unchanged. The value of the long forward position will most likely:

The long forward's value will most likely decrease. The long holder does not receive the dividends, so a higher expected dividend increases the present value subtracted from the spot price, while the agreed forward price stays fixed, leaving the long position worth less.

  1. AdecreaseCorrect
  2. Bincrease
  3. Cremain unchanged

Explanation

Long value = (S - PV of dividends) - PV of forward price. A larger dividend raises the PV of dividends, lowering the first term, while the contract price is fixed. The long holder does not receive dividends, so value decreases.

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