The risk-free rate is 5% and the dividend yield on the S&P 500 index is 2%. Which of the following is correct when a futures option on the index is being valued?
A. The futures price of the S&P 500 is treated like a stock paying a dividend yield of 5%.
B. The futures price of the S&P 500 is treated like a stock paying a dividend yield of 2%.
C. The futures price of the S&P 500 is treated like a stock paying a dividend yield of 3%.
D. The futures price of the S&P 500 is treated like a non-dividend-paying stock.
A
When a futures option is being valued the dividend yield is set equal to the domestic risk-free rate. In this case the domestic risk-free rate is 5%. A is therefore correct.
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