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CFA Level I · CFA Level I Exam · Arbitrage, Replication, and the Cost of Carry in Pricing Derivatives

A stock is expected to pay a dividend during the life of a forward contract on that stock. Holding the stock instead of a long forward position, the dividend is most likely treated in the forward price as:

The dividend is a benefit of owning the stock that lowers the forward price. A forward holder does not receive it, so the no-arbitrage forward price subtracts the future value of the dividend from the spot price compounded at the risk-free rate.

  1. Aa benefit of ownership that lowers the forward priceCorrect
  2. Ba cost of carry that raises the forward price
  3. Can item with no effect on the no-arbitrage forward price

Explanation

The holder of the stock receives the dividend, while the holder of a forward does not. This benefit of holding the underlying is subtracted from the cost of carry, so the forward price is lower. Ignoring it would allow an arbitrage.

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