Derivatives Forward Question

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?

Bilal Wrote: ------------------------------------------------------- > Will it be positive for the person holding the > long position to have a higher dividend yield > growth? huh?

As in who will benefit the most if the growth rate in dividend increases, the person who is in the short or long position on the equity index?

The long will. The current market price(spot S0) an index is S = g*D0/(r-g). When you estimate the future value, F = S x e power (rf - Dy ) n/N (index). If dividends grow above initial “g”, then the future Spot price (S1) will be greater than F, which is the long’s position gain.

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

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.

Yeah that’s why i got really confused

My assumptions are the following: 1. There should be time elapse between the contract date and dividends growth change. 2. I suppose that the consideration behind the example is not the future, but the spot price. Because once you’ve gone long on F and you hold the security to maturity and the g increases, the Spot price will also increase. On the maturity date, the Spot 1 will be above F0, because of increase in the dividends. I might be wrong though…

Analti_Calte_Equity Wrote: ------------------------------------------------------- > Bilal Wrote: > -------------------------------------------------- > ----- > > > Will it be positive for the person holding the > > long position to have a higher dividend yield > > growth? > > > huh? Very helpfull Analti u ass

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

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

This is confusing…

Im sexually confused

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?

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

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.