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FRM Part I · FRM Exam Part I · Pricing Financial Forwards and Futures

A zero-coupon bond with a current price of $940 is the underlying of a 1-year forward contract. The bond has 3 years to maturity and pays no interim coupons. The annual risk-free rate is 4% with continuous compounding. What is the forward price, to the nearest dollar?

The forward price is about $978. The bond provides no income, so its forward price is the spot price compounded at the risk-free rate for one year: 940 × e^0.04 ≈ 978. Discounting would incorrectly lower the price below spot.

  1. A$978Correct
  2. B$988
  3. C$902
  4. D$1,000

Explanation

A zero-coupon bond pays no income, so F0 = S0 e^(rT) = 940 × e^0.04 = 940 × 1.040811 = 978.36, about $978. The $988 option compounds for the wrong period (about 1.3 years). The $902 option discounts rather than compounds. The $1,000 option is arbitrary.

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