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

An analyst prices a forward contract on a non-dividend-paying stock that has no storage costs or other benefits. The stock trades at 50, the continuously compounded risk-free rate is not used, and the annual effective risk-free rate is 4%. The forward expires in one year. The no-arbitrage forward price at initiation is closest to:

The forward price is about 52.00. With no interim cash flows, the forward equals the spot price compounded at the risk-free rate over the contract term: 50 x 1.04 = 52. Using 50 ignores the time value of money, which an arbitrageur would earn by holding cash instead.

  1. A50.00
  2. B52.00Correct
  3. C54.00

Explanation

For an asset with no cash flows, F0 = S0 x (1+r)^T = 50 x 1.04 = 52.00. Choosing 50.00 ignores the cost of financing the spot purchase. 54.00 would require an 8% rate.

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