Explain this question to me (Question #77, GARP Practice Test)
I don’t understand why they subtract K from the forward price in the calculation. Couldn’t you just discount 1050 back 9 months to get to today’s price?
Three months ago, a company entered in a one-year forward contract to buy 100 ounces of gold. At the
time, the one-year forward price was USD 1,000 per ounce. The nine-month forward price of gold is now
USD 1,050 per ounce. The continuously-compounded risk-free rate is 4% per year for all maturities, and
there are no storage costs. Which of the following is closest to the value of the contract?
Explanation: The forward price is computed as follows:
F 0 = 100 x (F 0 - K)e -rT
F 0 = 1,050
K = 1,000
r = 0.04
T = 0.75
F = 100 x (1050 - 1000)e -0.04*0.75 = 4,852
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