1) Suppose the underlying asset of a forward contract is a stock. This stock’s current price is S and it doesn’t pay dividends. Assume T is the delivery time and r is the risk-free rate of interest per year with continuous compounding. Please derive the no arbitrage forward price F.
2) Consider an 8-month forward contract on AT&T stock. The current price of AT&T is $65. What is the current forward price if the risk-free rate of interest is 6% per year (continuously compounded)? If the forward price is $65, how can you take advantage of this arbitrage opportunity? (Please show me your arbitrage strategies with your arbitrage profit)
3) Please list and explain the three forms of market efficiency and describe one piece of evidence against the Efficient Market Hypothesis (EMH)?
4) Please answer the following three questions. a. How does one country’s price level affect equilibrium exchange rate in short run? b. An investor in Canada purchased 100 shares of IBM on January 1st at $93.00/share. IBM paid an annual dividend of $0.72 on December 31st. The stock was sold that day as well for $100.25/share. The exchange rate is a $0.71/Canadian dollar on January 1st and $0.68/Canadian dollar on December 31st. What is the investor’s total return in Canadian dollars? c. The Mexican peso is trading at 11 pesos per dollar. If the expected U.S. inflation rate is 3% while the Mexican inflation rate is 22% over the next year, what is the expected exchange (pesos/$) rate in one year?