Question 1. Suppose a stock currently trades at $60. The stock\'s semi-annual di

Question

Question 1. Suppose a stock currently trades at $60. The stock's semi-annual dividend is expected to be $4, paid in 5 months from now. Note that the dividend is paid after the future expires. Assume a 7% Continuously compounded risk-free rate.

Question 2.  Calculate the future price of a 3-months future contract on this stock, as implied by the above information.

Question 3. If the fair future price that you calculated above suddenly changed to $59 but all else was unchanged and there was no news about the company, then explain how you could conduct a risk-free arbitrage. Assuming that the future is mis-priced. you're best able to show the step using an arbitrage table. Hint: construct the arbitrage table by having some position in the physical mispriced future above and an offsetting position in a synthetic future. The synthetic future can be constructed using stocks and bonds.

Explanation / Answer

61.1

Future value of contract = Continuous compounding formula = S*e^(r%*t) Spot price (S) 60 risk free rate (r%) 7% Term of the future (t)in years 3 months or 0.25 years

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