A forward contract has 6 month until delivery date and a contract price of 50. the underlying asset has no cash flows, or storage costs and is currently priced at 50. Because no funds are exchanged upfront and because the contract value and current asset are the same, the analyst states that there is no current or potential credit risk. Critique this statement ( that’s my addition).
Correct, since the Current value fo the forward contract is 0, there is no potential credit risk and/or current credit risk. But for some reason I still want to say there is Potential :), but then again sometimes I read into questions too much.
agree w/ analyst. there may someday be potential that will turn into current, but there isn’t any credit risk now (i think)
No…that statement is wrong. There should be some potential credit risk. Just because spot and contract price is the same now, it doesn’t mean the future spot price will equal to the contract price.
There is a potential risk if the price of the asset changes before the contract expires.
Well… Potential credit risk is not current credit risk until settlement date…
derswap07 Wrote: ------------------------------------------------------- > There is a potential risk if the price of the > asset changes before the contract expires. Agree, which has not happened yet. If the spot prices goes to 51 tomorrow, then there is potential credit risk and no current credit risk. that’s my understanding at least.
Yes but at that point in time, there is no potential b/c the spot = future price. See this is why I dont like to overthink b/c if I did I would have said well there still is potential b/c the price can change to 51 or 49 yada yada yada… I think we have to look at it at that point in time. Mo34 what is the correct answer? Did you see this somewhere?
Oh, god! I hope this exam doesn’t turn into an English grammer exam.
bigwilly Wrote: ------------------------------------------------------- > Yes but at that point in time, there is no > potential b/c the spot = future price. See this > is why I dont like to overthink b/c if I did I > would have said well there still is potential b/c > the price can change to 51 or 49 yada yada yada… > I think we have to look at it at that point in > time. > > Mo34 what is the correct answer? Did you see this > somewhere? I agree with you, but Schweser thinks otherwise. They say there is potential credit risk equal to the difference between the current price ( 50) and the PV of the forward price (50). I believe this is BS, and just needed your confirmation 
THOSE F#CKERS! PV of forward price?? Come on now. Someone correct me if I’m wrong, but since when do you take the PV of a forward price???
Mo34, I still think the statement is wrong. However, the explanation that schweser gave is 100% BS.
ws Wrote: ------------------------------------------------------- > Mo34, I still think the statement is wrong. > However, the explanation that schweser gave is > 100% BS. Ws, So you’re saying at this point in time ( spot price = forward price) there is a potential credit risk ? I disagree with you, potential is associated due in the future, there is no payment due in the future at this point. Prices will move one way or another tomorrow, and there will be potential credit risk for one of the sides, but not if the spot price = forward price.
The only thing I’ll say is that there is “potential” credit risk if the Hedge is closed at that moment and the seller never delivers the good and by the time the buyer realizes it the spot price has changed… But see this is why I hate overthinking questions and the CFAI always says don’t over think questions…but what constitutes overthinking….
Ok…so the fact that you people are going back & forth about this means that you know your gunna get a 100% on the Individual & Institutional PM questions that will no doubt be on the exam (unlike this material).
No, just means this is easier to argue about
mo34 Wrote: ------------------------------------------------------- > ws Wrote: > -------------------------------------------------- > ----- > > Mo34, I still think the statement is wrong. > > However, the explanation that schweser gave is > > 100% BS. > > > Ws, > > So you’re saying at this point in time ( spot > price = forward price) there is a potential credit > risk ? > > I disagree with you, potential is associated due > in the future, there is no payment due in the > future at this point. Prices will move one way or > another tomorrow, and there will be potential > credit risk for one of the sides, but not if the > spot price = forward price. I think we are all arguing English, instead of finance, here. My only point is the statement as written is wrong (in my opinion), since the analyst can’t say that there is no potential credit risk. My understanding of potential credit risk result from the future movement of spot price (as soos as future spot price is different from contract price, that will result in potentail credit risk prior to contract expiration). Using the statement, yes, you are right. However, I am reading it as future potential creitd risk. Bottom line, we all understand the concept. Like I said, I would hate to fail on the “reading” part of this exam.
Sell spot Buy Fwd. Earn RFR. ??? Profit!
> My understanding of potential credit > risk result from the future movement of spot price > (as soos as future spot price is different from > contract price, that will result in potentail > credit risk prior to contract expiration). Ws, I am not picking on the English (English is my 3rd language), I am just clarifying a possible misconception. Potential credit risk is not associated with the future movement of spot price. It is associated with a payment currently due in the future as of today (as a result of prior movement of prices or interest rates) So if the spot price went up, the position has value to the long = NP (Spot - Forward price), but he will only get this value in the future, so it is classified Potential Credit Risk as he might not get it. The PV of this difference*NP is the value of the potential credit risk.
Currently, since spot=contract price, nobody had to pay anything. We all agree that there is no current credit risk. So, you are saying that potential credit risk resulted from a prior movement of price? Well, I am saying that potential credit risk will result depend on the future price movement. Is that what we disagree on??? This is how I help myself to think these: I entered a FRA, cost me nothing to enter. As of today, $0 current credit risk; however, I don’t know my potential credit risk because that depend on the interest rate movement. Please correct me if I am wrong. Thanks!!