I know that TECHNICALLY since the actual cash payment on a forward won’t occur until expiration (assuming no netting), you discount the payoff to get the value at Time 0, however pretty much every example I have done at level 3 just uses Ft-F0 and calls it a day. Think of every “hedged return vs unhedged return” problem we have done?
In this problem, I didn’t discount by the CAD Rf Rate so I was wrong. So how do we know when to discount and when not to?
For a forward such as the EUR forward provided …
The original contract had been set up with F=1.63 CAD/EUR. Now you are re-evaluating it at an intermediate later point when the Forward is till 6 months Time to expire.
So you need to use SFFD to do the valuation of the Forward at that point in time
By SFFD I mean St / (1+rforeign)^(T-t) - F/(1+rDomestic)^(T-t)
Here T-t = 6 months or 1/2 year.
Compare this with the RedRiver problem (I believe 2008, where the valuation of the forward was AT EXPIRY - and there the rates DID NOT HAVE TO BE USED).
I actually did it the second way, where you use covered IRP to find the 6 month forward, then use Ft-F0… i just forgot to discount that.
Thats a good point, i guess because i have literally never run into a problem that has you value the forward at a time other than current, i just let it slip. Reminds me more of a LII problem than LIII. So i guess all those “calculate hedged vs unhedged” problems are actually after the fact, so there is no discounting. Thanks.
Actually over here - you just used the Spot at Time t and then discounted the forward to determine the effect.