In: Finance
Spot Price = $50 | Risk-free rate = 6% | Continous Dividend = 8% | Time to expiry = 1 year
Price of Prepaid Forward contract is price paid today for a contract where stocks would be received at the end of Year 1. It is essentially Spot price - Dividends missed out.
Therefore, Price of Prepaid Forward Contract formula = Spot Price * e-Dividend Yield * T
Price of a Prepaid Forward Contract = 50 * e-8% * 1 ----------------------(Continuous dividend of 8%)
Price of a Prepaid Forward Contract = 50 * 0.92312
Price of a Prepaid Forward Contract for ABCD stock expiring in 1 year = $ 46.16
The Price of a Forward contract is the price of the stock continuously compounded at risk-free rate minus the Dividends missed out.
Therefore, Price of a Forward Contract formula = Spot Price * eRisk-free rate -Dividend Yield * T
Price of a Forward Contract = 50 * e(6% - 8%) * 1
Price of a Forward Contract = 50 * e-2%
Price of a Forward Contract = 50 * 0.98020
Price of a Forward Contract for ABCD stock expiring in 1 year = $ 49.01
Hence, Price of a Prepaid Forward Contract is $ 46.16 and Price of a Forward contract is $ 49.01