MGMT 476 Homework #2: Chapter 3: Pricing Forwards

1. List the 2 factors that could cause futures prices to deviate from forward prices. How
important are these factors in general?

2. The forward price of wheat for delivery in three months is $3.90 per bushel, while the
spot price is $3.60. The three-month interest rate in continuously compounded terms is 8% per
annum. Is there an arbitrage opportunity in this market if wheat may be stored costlessly?

3. Suppose that the three-month interest rates in Norway and the US are, respectively,
8% and 4%. Suppose that the spot price of the Norwegian Kroner is $0.155.
(a) Calculate the forward price for delivery in three months.

(b) If the actual forward price is given to be $0.156, examine if there is an arbitrage opportunity
4. Three months ago, an investor entered into a six-month forward contract to sell a
stock. The delivery price agreed to was $55. Today, the stock is trading at $45. Suppose the
three-month interest rate is 4.80% in continuously compounded terms.
(a) Assuming the stock is not expected to pay any dividends over the next three months, what is
the current forward price of the stock?

(b) What is the value of the contract held by the investor?

(c) Suppose the stock is expected to pay a dividend of $2 in one month, and the one-month rate
of interest is 4.70%. What are the current forward price and the value of the contract held by
the investor?

5. In the US, interest rates in the money market are quoted using an “Actual/360"
convention. The word “Actual" refers to the actual number of days in the investment period. For
example, if the interest rate for a three-month period is given to be 7% and the actual number of
calendar days in the three-month period is 91, then the actual interest received on a principal of $1
is 0.07 ×91/360 . Many other countries too (including the euro zone) use the Actual/360 convention,
but the British money-market convention uses Actual/365. This question and the next four pertain to
calculating forward prices given interest rates in the money-market convention.

Suppose the 90-day interest rate in the US is 3%, the 90-day interest rate in the UK is 5% (both
quoted using the respective money-market conventions), and the spot exchange rate is £1 = $1:75.

(a) What is the present value of $1 receivable in 90 days?

(b) What is the present value of £1 receivable in 90 days?

(c) What is the 90-day forward price of £1?