Pricing of Equity Forward Contract

CFA Level I Derivatives
#1

Hello!

Could anyone make me understand why do we deduct the PV of dividends from the spot price of the equity while calculating the value of a Forward contract?

I was solving this question lately,

Q. A person has entered into a 150 day forward contract on a stock at $80 and there is an expected dividend on the stock of $2.5 payable in 90 days. After 30 days the stock price has moved to $86. What is the value of this forward contract given risk free rate of 5%?

P.S. I understand the concept of convenience yield but I think we use it while calculating the forward price only.

Thanks!

#2

You subtract the present value only of dividends that will be paid between the inception of the forward contract and its expiration.

The spot price of the stock assumes that the owner will receive all future dividends. If you have a long position in a forward contract, then you don’t own the stock, so you won’t receive those dividends; therefore, you need to remove their present value from the spot price.

#3

Thank you! (:

#4

My pleasure.