Explanation

To solve this problem, we need to calculate the change in value of the forward contract when the risk-free rate increases by 1%.

Step 1: Calculate the original forward price

Using the forward pricing formula with continuous compounding:

$F = S \times \left[ \frac{(1 + R)}{(1 + Q)} \right]^T$

Where:

• S = Current stock price = USD 67.68
• R = Risk-free rate = -0.70% = -0.0070
• Q = Dividend yield = 0.44% = 0.0044
• T = Time to maturity = 2 years

$F = 67.68 \times \left[ \frac{(1 - 0.0070)}{(1 + 0.0044)} \right]^2 = 67.68 \times \left[ \frac{0.9930}{1.0044} \right]^2 = 67.68 \times (0.9887)^2 = 67.68 \times 0.9775 = USD 66.15$

Step 2: Calculate the new forward price after 1% rate increase

New risk-free rate = -0.70% + 1% = 0.30% = 0.0030

$F_{new} = 67.68 \times \left[ \frac{(1 + 0.0030)}{(1 + 0.0044)} \right]^2 = 67.68 \times \left[ \frac{1.0030}{1.0044} \right]^2 = 67.68 \times (0.9986)^2 = 67.68 \times 0.9972 = USD 67.49$

Step 3: Calculate the change in value

$\Delta Value = F_{new} - F = 67.49 - 66.15 = USD 1.34$

Why this makes sense: When interest rates increase, the forward price increases because the cost of carry decreases (you earn more on the cash you would have invested). For an existing forward contract, if rates rise, the contract becomes more valuable to the long position holder.

Why other options are incorrect:

• A (-USD 1.46): Results from mixing up R and Q in the calculations
• B (-USD 1.37): Change in risk-neutral forward price if R and Q are mixed up
• D (USD 1.43): Change in risk-neutral forward price for the equity, not the forward contract value