Could someone please explain to me in simple words these Q&As? 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 long pays the short at the maturity of the contract. B) The short pays the long at the initiation of the contract. C) The long pays the short at the initiation of the contract. D) The short pays the long at the maturity of the contract. Your answer: B was incorrect. The correct answer was C) The long pays the short at the initiation of the contract. 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. (I thot it was the other way around, +ve value means short pays to long and vice versa) Information related to a forward contract on a currency: The risk-free rate in the U.S. is 5% and 4% in Switzerland. The current spot exchange rate is $0.8611 per Swiss France (SFr). The forward contract will mature in 200 days. Based on the information given, what initial price should Lewis recommend for a forward contract on Swiss Francs based on a discrete time calculation? A) $0.8656. B) $1.1552. C) $1.0053. D) $0.9947. Your answer: A was correct! The value of a forward currency contract is given by: My q-bank doesn’t show up anything. Where F and S are quoted in domestic currency per unit of foreign currency. Substituting: (Doesn’t show up anything here either. How do they get A?) Thanks
I can help you with the second one logically so in order to correctly price the contract you need to have a no-arbitrage opportunity that means that you make the same amt of money no matter what ok so you can take 1chf invest at 1.04^(200/365) =1.0217233 chf (thats what you have in 200 days) OR you can take 1chf*0.8611=0.8611$*1.05^(200/365)=0.884431US because you need these two to be the same just divide for exchange rate 0.8844/1.021723=0.8656
- Forwards are set on a no-arb basis. So this stupid question is saying “If I have something with a value >0, do I pay for it or not?”. The answer is only if the other guy notices. 2) F/S = (1+rd)/(1+rf) So F = $0.8611*(1.05/1.04)^(200/365) = $0.8656 Edit: Correct typo
chris … you are right but they are talking in the curriculum about the off market fra… I don’t know who would set it up like that though and why?
The cirriculum used off market FRAs as a way to look at how swaps worked. The analogy isn’t perfect, but pretty close.
my take on the first one: if the forward has positive value, that is positive for the long and negative for the short. A forward has to have 0 value to all parties, so the long must pay the short to even things out.
to remember who has the positive value i use a byline to remember ‘loong po’ long is positve…meaning if it is positive it is value to the long…he gat to pay for it