Financial Modelling 2557A/B Lecture Notes - Lecture 8: Arbitrage, Dividend Yield, Compound Interest
17 Apr 2017
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Forward contract: agree on price now, pay/receive later. Fully leveraged purchase: investor borrows the full amount. Prepaid forward contract: pay agreed price today, receive asset later. When pricing prepaid forwards on stocks with discrete dividends, For stock indexes containing many stocks, it is common to model the dividend as being paid continuously at a rate proportional to the level of the endex. The constant rate is called the dividend yield delta o. Similar to the concept of continuous compounding interest rate. At each moment, paid dividend will be reinvested to buy delta*change in time more shares. If we wish to invest today to have 1 share at time t, must buy e^-delta*t shares today. Tailing: adjusting the initial quantity to offset the effect of income from the asset. Cash and carry: a transaction in which you long the underlying asset and short the offsetting forward contract.
