Derivatives Forward Question question, position, afternoon, positive, index

lunarfollies

In one of the schweser mock exams, i think book 2 afternoon sessions there's a question that asks about the growth of the dividend yield.

F = S x e power (rf - Dy ) n/N (index)

Will it be positive for the person holding the long position to have a higher dividend yield growth?

I don't really find it positive however schweser says it is ..

Any advice?

giants2010

Yes, but they say dividend yield, so would the index not be more valuable, and therefore command a higher price

mp3bu

An increase in the dividend yield should decrease the derivative price otherwise your forward contract would increase in value along with an increase in yield/income which should not fundamentally occur otherwise you'd have an arbitrage opp.

All income received while holding a derivative asset (forward, future, option, etc...) should be subtracted. I don 't think you can assume that the underlying index/stock price increases just based off of the increased dividend yield. We know it should, but for the exam I wouldn't assume that the underlying increased in value unless specifically told so.

wilslm

May be it's confusing but here is what is clear to me.

Let us say today IBM is trading at $100. You buy a forward contract on IBM for $110 which expires in 1 year.

After two months IBM declares a special dividend of $10 to be paid a day before year end (i.e., a day before contract expires). The price of IBM will then drop $10 on ex-dividend day. You will then pay $110 to own a stock that has just dropped $10.

You (the long) clearly lost (not gained as stated above) due to a rise in dividend. No?

kingstongal

They say dividend yield growth, so id assume i higher dividend yield g will increase the index level i.e. the future spot

jarobi04

Heres my opinion, he has already locked in the F rate, so what happens after will not affect the rate that he will get, but an increase in div should theoretically make the index price/level increase, so the difference between F and S is now greater



Edited 1 time(s). Last edit at Monday, May 9, 2011 at 09:01AM by pedpenny.

senlinlang

Yeah that's why i got really confused

RMontgomery

I don't know about the particular problem mentioned in Schweser, but I couldn't follow why they say the long benefits.

Forward price = FV (Spot price0) - FV (Dividend).

If dividends increase after you went long the contract, the price of the contract will drop, because you will now deduct more in the above formula, making the price go lower.

scarecrow

I thought growth rate in dividend increases Dividend Yield which then decreases F .. my bad thanks though! appreciated

genuinecfa

Bilal Wrote:
-------------------------------------------------------

> Will it be positive for the person holding the
> long position to have a higher dividend yield
> growth?


huh?