Exercise 12.2

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Exercise 12.2

Postby rer » Wed Nov 28, 2012 8:17 pm

Hi Mark,

I was wondering why the forward with potential exercise rights between time interval [t_1, t_2] in Exercise 12.2 is really any more valuable than a normal forward, because isn't it just like comparing an American and European call option on a non-dividend paying stock? The value of the forward contract before expiry is S_t - K * exp(-r * (T - t)) >= S_t - K with equality only at t = T. Therefore it should never be optimal to exercise the forward early. (Intuitively, if we are at a time within [t_1, t_2] and the stock is much greater than K, we might consider exercising, however this would be sub-optimal because we are giving up the possibility of the stock going even higher...). Clearly the 'American' forward will be at least as valuable as a normal forward, but surely it's not correct to claim the value will be more valuable? Unless, of course, I'm wrong!!! Please do help!

Many thanks and best wishes!

Ross
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Re: Exercise 12.2

Postby mj » Fri Nov 30, 2012 12:49 am

if there are dividends it may be worth more, if not then it's the same I think.
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