In: Finance
A forward contract on a stock is struck at time t so that no money is exchanged initially. The forward price is F, to be delivered at time T. However, there will be a dividend paid out by the stock at time td. What is known is that the dividend will be a known percentage, d, of the stock price. The dividend size, dS(td), depends on the unknown future stock price and so it is a random variable. Use a no arbitrage argument to determine the forward price F;
F = forward price
T = Time to maturity
Td = Time at which the dividend will be paid
d= %dividend of the S(td) stock price
Lets assume, r = risk free rate & spot price of stock at present = S(t0)
Present Value of the dividend paid at time td:-
= dS(td)*e^(-r*td)
Forward price of the contract = F = (S(t0) - PV of Dividend)*e^(r*T)
= (S(t0) - dS(td)*e^(-r*td))*e^(r*T)
F = S(t0)*e^(r*T) - dS(td)*e^(td*T)