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Math Help - John Hull, determination of future prices

  1. #1
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    Nov 2006
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    139

    John Hull, determination of future prices

    I am struggling with this:

    Hull says that when an investment asset will provide income with a present value of I during the life of a forward contract, we have

    F_0 = (S_0 - I) * e^ (rT)

    where F_0 = forward or future prices today
    S_0 = price of the asset underlying the forward or future contract today
    r=zero coupon risk free rate of interest per annum expressed with continuous compounding , for an investment maturing at the delivery date(ie, T in years)

    I really really do not get why? Is this F_0 nothing else than the face value of this bond? I am getting so puzzled. Maybe someone here has the Hull, so for those ones, the page is 105. I hope someone can come and help, I would so much appreciate it. Thanks.
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  2. #2
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    Joined
    Sep 2007
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    9

    Forward contract

    The reason "I" is subtracted is because the holder of the underlying asset would receive income between the valuation date and the delivery date wheras the holder of a forward contract would not.

    I can see how the equation looks a little like that for face value. However remember that "I" does not relate to all future income from the underlying asset only that between the valuation date and the delivery date.
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