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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 asset has a spot price of 100 and pays a known cash income of 4 in six months. The annual risk-free rate is 6% with annual compounding. The no-arbitrage price of a one-year forward contract is closest to:

The forward price is about 101.9. Compound the spot price for one year to 106.00, then subtract the future value of the 4 income received at six months, which is about 4.12. Income received by the holder of the asset lowers the forward price.

  1. A101.9Correct
  2. B102.0
  3. C106.0

Explanation

FV of the income at one year = 4 × 1.06^0.5 = 4 × 1.02956 = 4.118. F0 = 100 × 1.06 − 4.118 = 106.00 − 4.12 = 101.88, about 101.9. Using 106.0 ignores the income; 102.0 subtracts the undiscounted-to-forward value of 4 without compounding.

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