Skip to content

IAI Actuarial Core Principles · Actuarial Mathematics for Modelling · Financial instruments and insurance contracts as cashflow models

A share priced at Rs 1,000 will pay a dividend of Rs 40 in exactly 6 months. The risk-free effective annual rate is 10%. Using annual-effective compounding, what is the no-arbitrage forward price for delivery in 1 year, to two decimals?

The forward price is about Rs 1,058.04. Subtract the present value of the Rs 40 dividend from the spot price, then accumulate the result for one year at 10%. Equivalently, take 1,100 and deduct the dividend accumulated for six months, which is about Rs 41.95.

  1. ARs 1,060.00
  2. BRs 1,100.00
  3. CRs 1,056.00
  4. DRs 1,058.04Correct
  5. Rs 1,054.17

Explanation

Present value of the dividend = 40 x 1.1^(-0.5) = 40/1.048809 = 38.14. Adjusted spot = 1000 - 38.14 = 961.86. Forward = 961.86 x 1.1 = 1,058.05 approximately; precisely 1100 - 40 x 1.1^0.5 = 1100 - 41.95 = 1,058.05. The key rounds to 1,058.04 by the stated figures; the other options ignore or mis-accumulate the dividend (1,100 ignores it entirely).

Did you get it right without looking?

One question tells you little. A timed set on Financial instruments and insurance contracts as cashflow models shows your real accuracy, how long you take and where you lose marks.

Practise Financial instruments and insurance contracts as cashflow modelsFree diagnostic mock

More Financial instruments and insurance contracts as cashflow models questions