"Derivative"exercise:Spot exchange rate and forward exchange rate
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Questions 1:
There are two forward contracts, contract 1 and contract 2, on the same underlying. The underlying makes no cash payments, does not yield any nonfinancial benefits, and does not incur any storage costs. Contract 1 expires in one year, and contract 2 expires in two years. It is most likely that the price of contract 1:
A、 is equal to the price of contract 2.
B 、is less than the price of contract 2.
C 、exceeds the price of contract 2.
Questions 2:
For a forward contract with a value of zero, a situation where the spot price is above the forward price is best explained by high:
A 、interest rates.
B 、storage costs.
C 、convenience yield.
B is correct. The forward price is the spot price compounded at the risk-free rate over the life of the contract. Because contract 2 has the longer life, compounding will lead to a larger value.
A is incorrect. The price of contract 1 will be less than the price of contract 2.
C is incorrect. The price of contract 1 will be less than the price of contract 2.
C is correct. If the convenience yield is high, holding the underlying confers large benefits, thus the spot price can exceed the forward price for a forward contract with a value of zero. Based on the formula
and an initial value Vt(0) of zero, large benefits γ explain why the spot price can exceed the forward price.
A is incorrect. High interest rates make the forward contract more valuable. Thus the forward rate is above the spot rate.
B is incorrect. High storage costs make the forward contract more valuable. Thus the forward rate is above the spot rate.
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