Use an arbitrage argument, analogous to the one in Table 11.1 on page 212, to prove that in a stochastic interest rate world, the strike price of a forward contract F_t(K, T) that can be entered costlessly at time t = 0 has to be

which is the forward price of a non-dividend paying underlying V at t = 0.

Table 11.1 Forward arbitrage portfolio

Transcribed Image Text:

Vo K= P(0, T)' Position Value at t = 0 Value at t= T Forward ST- K Stock -So -ST Bank account So Total sum So - So = 0 IT so – K