When you have cash and want to create a synthetic equity position, the denominator has rfr *value of cash portfolio. This makes sense because we have cash position which will earn the rfr. When we are converting the equity position synthetically into cash, we still multiply by rfr. We are invested in equity so shouldn’t we multiply by dividend rate at which the equity will grow?
Can somebody clearify this for me?
Thanks,
Equity doesn’t necessarily grow at the dividend rate; the price of equity can fluctuate wildly.
Cash, however, always grows at the risk-free rate.
Thus, when creating synthetic equity or fixed income from cash, we use the amount of cash we’ll have at the expiration of the forward contract: the future value of cash. And when creating synthetic cash from equity or fixed income, we also use the amount of cash we’ll have at the expiration of the forward contract: the fiture value of cash.
I wrote a couple of articles on this that may be of some help: