QUESTION 1.

A company’s stock price S₀ is $60 today and the continuously compounded interest rate is r = 3% per year. Suppose the company pays a dividend of $1 to its shareholders every quarter (four per year). The next dividend is due in one month’s time.

a)     Find the price of an eight-month forward contract on the stock.

[6 marks]

b)     Suppose the forward contract is trading at exactly $60, just like the stock. Is an arbitrage opportunity available? If so, how? If not, why not?

  [6 marks]

c)     Assume instead a continuous dividend yield. Estimate this yield from next year’s planned dividends. By how much does your answer to (a) change if you use this continuous dividend in your calculations?

[6 marks]

d)     Now suppose that S₀ = 60 is instead the spot price of crude oil, r = 3% per year, and storage is paid at a continuous annualized rate of c = 5% of the spot price. What are the possible values for the eight-month forward price of oil?

[6 marks]

e)     Give an example of a supply or demand effect which could produce a one-year oil forward price of $50.

[6 marks