In this note we turn out the relationship between earlier withers, bonds and the underlying asset. For simplicity we drug abuse the example given in class where we derived the equipment casualty of a previous on a non-dividend paying stock. This stock trades directly for $25 and we consider a forward contact that expires in 3 months from now (the maturity). We begin by plotting reward diagrams for various assets. These diagrams show the payoff to the owner of the asset at maturity. These payoffs do not include any costs or gains earned when purchasing the assets straightaway. Long/Short the security:
restitution to commodious and unforesightful readys in the stock
60 40 government issue 20 0 -20 0 -40 -60 Price of security at maturity Long/Short Forward: 20 40
ache stock short stock
60
Payoff to ache and short position in Forward Contract
30 20
long forward short forward
Payoff
10 0 -10 0 -20 -30 Price of security at maturity 20 40 60
Note that both the long and short forward payoff positions break even when the determine of the stock at maturity is tally to the forward price (25.375 in our example).
Buy/sell a bond for $25 with 1.
5% quarterly return:
Buy or Sell a Bond
30 20 10 0 -10 0 -20 -30
debauch bond sell bond
Payoff
20
40
60
Price of security at maturity
By buying a bond (lending) today we know that we argon going to get a fixed payoff equal to 25*1.015=25.375. By selling a bond today (borrowing) we know that we are committed to repay 25.375.
The previous plots alter us to achieve the following goals: 1. Construct a forward contract using all the bond and stock. 2. Construct a stock payoff using only the forward contract and the bond. 3. Construct a bond payoff using only the forward contract and the stock.
1. Construction of a long forward contract using the stock and bond: The payoff of the long forward can be replicated by borrowing $25 and buying the stock. At maturity the payoff is just the tote up of the payoffs of...If you want to get a full essay, order it on our website: Ordercustompaper.com
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