Exam: CH 5 Forward and future prices Flashcards
What is an investment asset?
An asset that t is held for investment purposes by the significant portion of investors. Example:
– Treasury bills
– Stocks
What is a consumption asset?
An asset that is held primarily for consumption or manufacturing.
Example
– Corn
– Cattle
What is short selling?
involves selling an asset that is not owned by the investor. This is not possible with every asset.
When shorting a stock who gets the income (dividends, ect)?
• All income from the stock (dividends, etc) is returned to the stock’s owner
What 4 assumptions are held for our major market participants?
• Market participants are subject to no transaction cost when they trade
• Market participants are subject to the same tax rate on all net trading profits
• Market participants can borrow money at the same risk-free rate of interest as
they can lend money
• Market participants take advantage of arbitrage opportunities as they occur
Which are the easiest forward contracts to price and give two examples.
Non-income producing contracts.
e.g. non-dividend-paying stocks and zero-coupon bonds
What formula do you use to value forward contracts with no income?
f = S0 − Ke −rT
What formula do you use to Value of forward contracts with known income
f = S0 − I − Ke −rT
What formula do you use to Value of forward contracts with known yield
f = S0e −rT − Ke−rT
What is a convenience yield?
- Benefits from holding the physical asset are referred to as the convenience yield provided by the
community
What is cost of carry?
-is storage costs and interest that is paid to finance the asset less the income earned
on the asset
If F0 > S0erT then investor uses which strategy?
– Borrow S0 dollars at interest rate r for T years
– Buy one-contract’s worth of the asset
– Short a forward contract
– Investor makes F0 − S0erT on the transaction
If F0 < S0erT then any owner of the asset uses which strategy:
– Sell gold for S0 dollars
– Buy one-contract’s worth of the asset
– Invest the cash at interest rate r for T years
– Investor makes S0erT − F0 on the transaction
What happens If F0 > S0e(r−q)T
- profits can be made by buying the stocks underlying the index at the spot price and shorting future contracts. Often done by a corporation holding short-term money market investments
What happens If F0 < S0e(r−q)T
- profits can be made by shorting the stocks underlying the index and taking a long position in future contracts. Often done by a pension fund that owns an indexed portfolio of stocks
