'Forward Contracts on Bonds' question

Example from Schweser SS17: Question: A forward contract covering $10m face value of T-bills that will have 100 days to maturity at contract settlement is priced at 1.96 on a discount yield basis. Compute the dollar amount the long must pay at settlement for the T-bills. Answer: Unannualize the discount rate: 0.0196 * (100/360) = 0.005444 Settlement price: $10m * (1-0.005444) = $9.95m ==== Interpretation (expanding a bit more than the Schweser contents): In order for long to profit- if the above contract is executed, the interest rate at/or before the settlement date must be either at or below the current rate, where the value of the T-bill will either be stable or increase. Long can have losses if the interest rate increases and value of the T-bill declines. If a short was to execute the bilateral contract, the effect will be opposite, i.e. the short would sell at the same 1.96% rate and would profit from a rise in the discount rate and a loss in case of a rate decrease at/or before the settlement date. ==== Is the interpretation above correct. Thanks!

I think it should be the opposite. Long will benefit when i/r increase. Long has the obligation to borrow at the contract rate (say 5%). If i/r increase (say 10%), the long benefit by able to borrow at 5% instead of 10%. Opposite is true for shortist.

revenant Wrote: ------------------------------------------------------- > I think it should be the opposite. > > Long will benefit when i/r increase. Long has the > obligation to borrow at the contract rate (say > 5%). If i/r increase (say 10%), the long benefit > by able to borrow at 5% instead of 10%. Opposite > is true for shortist. This is a T-Bill foward not a Forward Rate Agreement (FRA) so no borrowing will take place. Sujan, I believe you are correct with your interpretation.

job71188 Wrote: ------------------------------------------------------- > revenant Wrote: > -------------------------------------------------- > ----- > > I think it should be the opposite. > > > > Long will benefit when i/r increase. Long has > the > > obligation to borrow at the contract rate (say > > 5%). If i/r increase (say 10%), the long > benefit > > by able to borrow at 5% instead of 10%. > Opposite > > is true for shortist. > > > This is a T-Bill foward not a Forward Rate > Agreement (FRA) so no borrowing will take place. > Sujan, I believe you are correct with your > interpretation. Sorry my bad. Brain beginning to switch off after 10 hours of studies.

Thanks job71188. You are indeed correct that this is a forward contract problem (Tbill in this case). Correct me if I am wrong but I have noticed that any problems concerning FRA will explicitly use the term FRA in it. And at all times I have ended up using the following formula to figure out the payment to the long at settlement, i.e.: notional principal * (interest difference bet ref and the forward rate/discount rate to the settlement date) Cheers

Actually the formula for FRA can be derived intuitively. I am able to get the correct answer on my first attempt at a FRA question without knowing theres a formula. Try to derive intuitively and that will be 1 formula less from your memory :slight_smile: