Value of forward = (spot/(1+foreigh)^t) - (forward/(1+domestic)^t) Usage: Credit risk
Payoff of forward (to Long) = (spot - contracted forward rate)*NP
Also in CFAI, in discussions related to “Managing risk of Foreign currency payment/receipt”, if spot prices changes at the time of forward expiration, the example say that nothing needs to be done.
Can sombody explain the scenarios when above formula should be used? Wouldn’t 2) needs to be calculated in scenario 3)
Your 1 and 2 are effectively the same thing. Both are derived from interest rate parity and used in this context to determine the credit risk to a counterparty in a futures transaction. Think about (spot/(1+foreigh)^t) as what you have as a long in a futures trade - it was the present value of the forward rate when the trade was put on and represents what youre long. Forward prices are effectively what you “owe” in the trade, or whats forgone by entering the transaction (0 sum hedge) as discounted by teh same mechanism. As (forward/(1+domestic)^t) changes, so will the value of the hedge to you as the long.
ok…what about 3)