Suppose that the price of the forward contract for the Treasury bond was negotiated off-market and the initial value of the contract was positive as a result. Which party makes a payment and when is the payment made? A) The short pays the long at the maturity of the contract. B) The long pays the short at the maturity of the contract. C) The long pays the short at the initiation of the contract.
can we get an explanation?
Here is the explanation from Schweser: If the value of a forward contract is positive at initiation then the long pays the short the value of the contract at the time it is entered into. If the value of the contract is negative initially then the short pays the long the absolute value of the contract at the time the contract is entered into. My question is why long needs to pay short when the value at initiation is positive, but gets paid when the value is positive after initiation?
Its C. Most forward contracts there is no payment at the initiation, but in this case they say it is positive. If you are the long you have to pay the initial positive value at the beginning to the short. If it stays positive (the value remains) or gets increasingly positive along the way the short pays the long after initiation. The long needs to fund the positive value at the outset if there is a positive value at the outset
Positive value to start with because it was negotiated off market. But in order to be compatible and comparable with all other swaps that are contracted now and have an initial value of 0 - the Long needs to pay the short - so the initial value becomes 0.
Thanks for the explanation.
Positive = value to long. Long needs to give value back to short to make it 0. Notice this is a FORWARD. Futures shouldn’t be off market.