There is a long forward contract on a single, non-dividend paying, stock with price St at time t. The payoff at time T is ST – F0,T where F0,T is the current forward price (t = 0). Now consider a one-step binomial tree where there is one time step to maturity, the current stock price S0 can increase to ST = uS0 or down to ST = dS0 at time T. The continuously compounded rate over the period is r. My question is
a) What current positions (t = 0) in the stock and risk-free investment will replicate the payoff of the long forward contract for any F0,T ? What is the replicating portfolio?
b) What is the current value of the forward contract?
