Question 2

b)The SCB bank offers a corporate client a choice between borrowing either cash at 11% per annum or borrowing gold at 2% per annum. (If gold is borrowed, interest must be repaid in gold. Thus, 100 ounces gold borrowed today would require 102 ounces to be repaid in one year). The risk-free interest rate is 9.25% per annum, and gold storage costs are 0.5% per annum. The interest rates on the two loans are expressed with annual compounding. The risk-free interest rate and storage costs are expressed with continuous compounding. Discuss whether the corporate client should borrow gold loan or cash loan?

c)The Top-pay Corp's share is expected to pay a dividend of $1 per share in two months and in five months. Currently the stock price is $50, and the risk-free rate of interest is 8% per annum with continuous compounding for all maturities. An investor has just taken a short position in a six-month forward contract on this stock.

i)What are the six-month forward price and the initial value of the forward contract?

ii)Three months later, the price of the stock is $48 and the risk-free rate of interest is still 8% per annum. What are the forward price and the value of the short position in the forward contract?