Lesson 2 Exercise 5: Two Dividend Dates With Known Yields

Consider a stock that pays two dividends before the maturity of a forward contract:

S₀ = $50 [Stock price at t = 0]
T = 8 months Forward expiration
Dividend dates       Dividend Rates
t1 = 2 mo                 Q1 = 2%
t2 = 5 mo                 Q2 = 4%
Risk-free rate = 6%

1. What should be the equilibrium forward price, F₀?
2. If the risk-free rate increases, will F₀ increase or decrease?
3. Under what condition
   1. for the forward price F₀ = S₀?
   2. for the forward price F₀ < S₀?

This exercise provides you with an opportunity to review some concepts of forward contracts on investment assets with two dividened dates with known yields. Please attempt to solve the question on your own and then check the answers in the textbook. Finally, please submit your work to the Lesson 2: Exercise 5 Drop Box to retrieve the Excel solution. The Excel solution is a locked file and can only be accessed once you have submitted your work to the Lesson 2: Exercise 5 Drop Box. Note: The cells which are highlighted yellow within the Excel worksheet are input data.

Review your answers in comparison to the solution. If you have wrong answers to the question, you should revisit the forward contracts concepts presented. And, if you still have difficulties understanding the material and why you made mistakes, please contact me.