Professor Feng
Formalities
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1. Assume the appropriate discount rates for 3, 6, 9 and 12 months are the same as the LIBOR rates given. A hypothetical stock, XYZ, has a price of $125 on 09/10/11 and will pay dividends as shown below: Date 11/11/11 02/11/12 05/11/12 08/11/12 Dividend Amount $1.50 $2.00 $2.00 $2.00
LIBOR Interest Rates1 3mo 0.35 % 6mo 0.50 % 9mo 0.69 % 12mo 0.82 % a) Determine the price to enter a long one-year forward position in XYZ. b) Calculate the one-year forward price for delivery of XYZ, as of 9/10/11 c) Assume the traded forward price is different from the value you calculated in part b. For concreteness, lets assume the forward price is lower by $2. How would you construct an arbitrage trade around this discrepancy? Be precise about long or short position in the stock, money borrowed and/or deposited at risk-free rate, and the timing of all cash flows. You can ignore transaction costs, stock borrowing/lending fee and all other market frictions. d) Plot the payoff pattern of a long position in a one-year forward contract at maturity. e) How would the 1-year forward price of XYZ on 9/11/12 have changed if the 3 month, 6 month, 9 month and 12 month LIBOR rates all suddenly increased by 1% (increased by 100 bps) while the stock price remained unchanged at $125? f) Another hypothetical stock, PQR, had a price of $100 on 9/11/12 and pays no dividends. What is the price to enter into a 1-year asset swap that receives the total return on XYZ and pays the total return on PQR? 2. Go to the website http://finance.yahoo.com, enter Ebay symbol (EBAY) to get the close price on Friday, 9/16/11. Assume Ebay will never pay dividends. Use this spot stock price information to calculate the forward price on 09/16/11 of a one-year forward contract for Ebay, assuming the interest rates in Question 1. 3. Suppose that a stock currently selling at S0 is just about to go ex-dividend. The immediate dividend will be D0 dollars. Show that the parity value for the futures price on the stock can be written F0 = S0 (1 + r) (1 d), where d = D0/S0 and r is the risk-free interest rate for a period corresponding to the term of the futures contract. Construct an arbitrage table
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demonstrating the riskless strategy assuming that the dividend is reinvested in the stock. Is your result consistent with the claim in class that the parity value is F0 = S0 (1 + r) FV(D)? [Hint: how many shares will you hold after reinvesting the dividend? How will this affect your hedging strategy? Also, notice that Ive defined d here slightly differently than I did in class. Here it is D0/S0; in class it was D1/S0.] 4. Prove using a no-arbitrage argument that the parity relationship for time spreads is F0(T2) = F0(T1) (1 + r) FV(D) where F0(T) is today's futures price for delivery at time T, T2 > T1, and FV(D) is the future value to which any dividends paid between T1 and T2 will grow if invested risklessly until time T2. r is the risk-free interest rate for the period from T1 to T2. [Hint: You need to maintain a continually-hedged position. Start with offsetting long and short positions in the two futures contracts. When the shorter-maturity futures expires, maintain your hedged position by replacing the contract with a position in the stock.]