In one of the practice tests on the CFA website we are given the following interest rates:
3m: 0,50%
6m : 0,50%
12m: 1,00%
We are supposed to calculate the forward price of a stock and need to deduct the PV of the dividends. “Midway believes that Yorktown’s stock price will increase over the next six months, but he does not want to purchase the stock today. To protect against the stock price rising over the next six months, Midway is considering a forward purchase. Yorktown’s common stock currently trades at $100 per share and isexpected to pay quarterly dividends of $0.75 per share, with the next dividend payment is expected 90 days from today.”
When calculating the PVs of the dividends we adjust the interest rates with the time factor:
PV D1 = (0.75)/(1+.005)90/360 = 0.7491
PV D2 = (0.75)/(1+.005)180/360 = 0.7481
(100 – 0.7491 – 0.7481) × (1.005)180/360 = 98.75
I understand the concept of adjusting for time, however in this example, with the interest being so low, I thought that 0,5% was the interest for both 3m and 6m, hence that it was not needed to time adjust it. But as I understand this, this is a yearly rate that is valid for 6 months? Could someone please explain this. Also, should we always assume that all interest rates given are yearly?
3m: 0,50%
6m : 0,50%
12m: 1,00%
We are supposed to calculate the forward price of a stock and need to deduct the PV of the dividends. “Midway believes that Yorktown’s stock price will increase over the next six months, but he does not want to purchase the stock today. To protect against the stock price rising over the next six months, Midway is considering a forward purchase. Yorktown’s common stock currently trades at $100 per share and isexpected to pay quarterly dividends of $0.75 per share, with the next dividend payment is expected 90 days from today.”
When calculating the PVs of the dividends we adjust the interest rates with the time factor:
PV D1 = (0.75)/(1+.005)90/360 = 0.7491
PV D2 = (0.75)/(1+.005)180/360 = 0.7481
(100 – 0.7491 – 0.7481) × (1.005)180/360 = 98.75
I understand the concept of adjusting for time, however in this example, with the interest being so low, I thought that 0,5% was the interest for both 3m and 6m, hence that it was not needed to time adjust it. But as I understand this, this is a yearly rate that is valid for 6 months? Could someone please explain this. Also, should we always assume that all interest rates given are yearly?