5.5 KNOWN INCOME

In this section we consider a forward contract on an investment asset that will provide a perfectly predictable cash income to the holder. Examples are stocks paying known dividends and coupon-bearing bonds. We adopt the same approach as in the previous section. We first look at a numerical example and then review the formal arguments.

Consider a forward contract to purchase a coupon-bearing bond whose current price is $900. We will suppose that the forward contract matures in 9 months. We will also suppose that a coupon payment of $40 is expected on the bond after 4 months. We assume that the 4-month and 9-month risk-free interest rates (continuously compounded) are, respectively, 3% and 4% per annum.

Suppose first that the ...

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