Reading 58, page 50, #4D An asset is currently worth $225. An investor purchases a forward agreement to buy the asset in one year at $235.69 Suppose that at expiration the price of the asset is $190. The value of the forward contract at expiration is: 90 - 235.69 = -$45.69 The loss to long position = -45.69 “The gain on the asset = 35 (based on 225 - 190)” <
The gain on the asset represents a theoretical gain by being able to purchase the asset at a cheaper price. At t=0, the investor could have purchased the asset at $225. Now they are able to purchase it at $190.
The loss on the position (at the time you enter into the forward agreement) for the long is 10.69 (asset is worth $225, you have to buy it for $235.69) The loss on the asset at expiration for the long is $35 (asset is worth $190, it was worth $225 when you entered into the forward agreement). Total loss to long = $45.69
thommo that seems logical to me, but the actual answer is: “Gain on asset = 35 (based on 225 - 190)” In 4E the price of the asset is 240 at expiration. The gain to the long is: 240 - 235.69 = 4.31 (yea, seems logical, I understand) But, “the loss on the asset is -15, based on 240 - 225.” (mmm, I don’t understand. The price of the asset went up and we are long, so why is it a loss? The answer says: “The loss of 10.69 is the risk free rate of 4.75% applied to the initial asset price of 225.” Any feedback helps…
Choices for investor: Buy asset today at 225. He entered into a forward contract -> with a price of 235.69. Buy asset 1 year later at 190… (expiration price). In terms of buying asset now vs. later - that he was able to buy it at expiration for 190 is a gain for him vs. buying it today. Since the price of asset dropped in the period. It is a loss in terms of what he had to pay. He had to pay 235.69 -> due to the forward, but market price was only 190 -> so a loss of 45.69.