Consider a security sells for $1000 today. A forward contract on this security expires in 1 year is priced at $1100. RF rate is 6.75%. I understand the value of this contract is 1000 - 1100/1.0675 = -30.44. Can anyone explain why the payment is made from the short to the long? I thought negative value means that it’s a gain to the short so the short should receive the payment from the long?
If you had a long position in this forward contract, the value of your position would, indeed, be negative; if you wanted to terminate the contract, you would need to pay the counterparty (short) $30.44.
However, if you don’t have a long position in this forward contract, but you’re considering one, the only way you would enter into it is if the counterparty (short) were to pay you $30.44 as an inducement; why else would you make an agreement in which you start at a loss?
Reread the question to see whether they’re talking about the value of an existing position, or the cost to enter into a new position.
Thanks S2k…that makes total sense.
Cool!