When we find the net gain on a forward. Say the asset sells at 100 and forward price is 105 (5% risk free rate), and at expiration the asset price drops to 95. The investor is short. So the value of the forward to investor is = 95-105 = -10 = 10 for the short side >>> Loss on asset is = 95-100 = -5 Which makes the net gain 5. If the investor is short, why is the loss on asset subtracted from his gain? Question is also what does net gain mean then? Is it always equal to the risk free rate?
He will sell if for $105. If it is at $95 at expiration, his gain is +$10. He could have sold it short on day 0, and invested the proceeds at 5%. So by year end, he has $5 in interest +$100 = $105. He buys the asset to cover his short position and pays $95, pocketing +$10 in gains.
No I mean, he enters into a contract to sell the security for 105.
Right that’s what was said above…he will sell the security for $105, he is short the contract. If he was a buyer, then he has bought the contract for $105, meaning that he will pay $105 for the asset, and he would have lost $10. Reason is that instead he could have borrowed $100 today to buy the asset for $100, paying $5 in interest a year later. At that time, the asset is worth $95, so he already lost $5 on the asset plus $5 interest, a total of -$10.