Prepaid Variable Forwards

CFA Level III Portfolio Management
#1

Can Someone help me clarify the following:

Prepaid Variable Forward:

1- If the share price at pre-specified date is < put strike price:

  • PVF physically settled: investor has to deliver all of his shares

-Cash settled: an investor has to pay the dealer the then current value of shares

2- if the share price is > put strike but < call strike:

-physically settled: deliver shares worth put strike price

-cash settled: pay the dealer the put strike price

#2

I wrote an article on prepaid variable forwards that covers this in great detail . . . with pictures!: Prepaid Variable Forward (PVF) | Financial Exam Help 123

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Suppose that you enter into a PVF on 1,000 shares of ABC stock: the lower (put) strike is $40/share, the upper (call) strike is $50/share.

The payoff at expiration depends on the price of ABC shares at expiration:

  • If the price is less than $40/share, you deliver the value of 1,000 shares; e.g.:
    • $30/share: deliver $30,000 or 1,000 shares
    • $35/share: deliver $35,000 or 1,000 shares
    • $39.99/share: deliver $39,990 or 1,000 shares
  • If the price is between $40/share and $50/share, you deliver $40,000 in value; e.g.:
    • $40/share: deliver $40,000 or 1,000 shares
    • $45/share: deliver $40,000 or 889 shares (= $40,000 / ($45/share))
    • $50/share: deliver $40,000 or 800 shares (= $40,000 / ($50/share))
  • If the price is above $50/share, deliver $40,000 plus 1,000 × (share price − $50) in value; e.g.:
    • $55/share: deliver $40,000 + 1,000($55 − $50) = $45,000 or 818 shares (= $45,000 / ($55/share))
    • $60/share: deliver $40,000 + 1,000($60 − $50) = $50,000 or 813 shares (= $50,000 / ($60/share))
    • $75/share: deliver $40,000 + 1,000($75 − $50) = $65,000 or 867 shares (= $65,000 / ($75/share))
    • $100/share: deliver $40,000 + 1,000($100 − $50) = $90,000 or 900 shares (= $90,000 / ($100/share))

There you go.