Given the following, who bears credit risk: - Company is based in USA. - JPY is foreign currency - We are short a 2-year forward on JPY denominated in USD at 15.00 JPY/USD fwd - Spot rate is 17.50 JPY/USD - Compound annual interest rates for two-year period are 1% in JPY and 10% in USD. So calculation for value to long is: (17.50/1.01) – (15.00/1.1) = 3.7 Since this is positive, I thought the long bears credit risk, but the answer says our company (the short side) bears the credit risk. Why does the company bear credit risk here?
Not sure if this is right but I will give it a shot:
Domestic currency is USD and foreign currency is JPY so you need to invert the exchange rates to have Domestic/Foreign
Not sure how much time is left to maturity (which will impact denominator) but I will just assume 1 year
Payoff to Long: Spot/(1+Rf) - Forward/(1+Rd)
.0571/(1.01) - .0667/(1.1) = -.0041
Payoff is negative to long so positive to short. Short bears credit risk
@tgile512 - I assume that you’ve been studying REALLY hard that you forgot to change your status to L3 candidate? If not, why AREN’t you in L3?
Thanks for pointing that out, completely forgot to change it!
Yep, nailed it…
Just on the currency topic – is it correct to label a “put on the yen” as a “put on USD/JPY”?
I’m getting confused which way this goes (even holding the dom/foreign convention steady).
Is ‘we’ the company or is ‘we’ the short and the company the long?