Two partites enter a forward contract to deliver s&p 500 at a price of $375,000 in 2 months. When the forward contract expires, value of s&p 500 was 350,000 and the long was unable make a cash settlement. The short party is most likely obligated to: A- default on the forward contract B- do nothing until the long makes the payment C- accept delivery of s&p 500 stocks from the long D- deliver the portfolio of s&p500 stocks to the long My answer was B. because default on the forward contract can only be done by the party owing the money as in this case long owes the money so the he/she is one making the default. the short on the other hand cannot make the default so A is wrong, but as he is willing to recieve the money so he will wait and do nothing . C and D are just space fillers so dont even read them… Any suggestions. This is from the CFA Mock 1 exam and somebody emailed it to me, and he is saying A. What do u think guys???
I answered B, because at the end of the contract, the long owes 25000, and is more likely to default. So the most correct answer is B, where the short would do nothing until money is collected.
i’d say c short’s making a profit no?
long owes 25000 - definitely B!!
but index forwards and futures are only settled in cash and if long is unable to pay cash that automatically means he is defaulting on the forward. How he can deliver the stocks.
I think it was B too, as it was a cash settlement, so there is no transfer of the stocks involved…
The point goes to Glimmer
Forward contracts are not settled following a standard. If i go into a forward contract to get gold, my expectations are to get gold, money or i’ll go after him in court and win… now consider that the question most probably would add : the short “most probably” would be obligated to:… consider B, he gets nothing. As far as the short is concerned he wont get payment consider C, he the contract would be settled. Correct me if i’m wrong but if i were the short, i’d “most probably” accept delivery… my opinion and not 100% sure so please someone enlighten me
‘The short party is most likely obligated to’…he is not obligated to take the stocks, so i stick with B.
jo_l point here is that the question dont give much information so I am going by what is standard, so the book says that mostly settled in cash so thats why i am saying cash. But you are right foward can be customized to meet the needs of parties invloved and later on they can negotiate the settlement if one defaults. second as there was no choice for law suit in the question so I am not thinking about it. well, i just wanted to discuss it I dont even know I am right or wrong, thats why I put it up for discussion.
What am I missing here? Are we talking about an index or a stock? C & D are there just to misslead you.
S&P 500 index
jo_l Wrote: ------------------------------------------------------- > Forward contracts are not settled following a > standard. If i go into a forward contract to get > gold, my expectations are to get gold, money or > i’ll go after him in court and win… > now consider that the question most probably would > add : the short “most probably” would be obligated > to:… > consider B, he gets nothing. As far as the short > is concerned he wont get payment > consider C, he the contract would be settled. > > Correct me if i’m wrong but if i were the short, > i’d “most probably” accept delivery… > > my opinion and not 100% sure so please someone > enlighten me Accept delivery? If you’re short and the contract can be settled by delivery, it’s the short doing the delivering.
short expects prices to go down… it went down, he expects payment or delivery… maybe you misread the question?
No he doesn’t. He expects to either deliver something and get paid $375,000 or he expects a cash settlement of $25,000.
“A” is the correct answer… Since u defaulted I am not giving you anything, even if u come with money later on…so B is out. choice C - doesnt make sense to me…as we will be exchanging index for the index… D is obviously not going to happen…
“Default” is a bad thing. The short doesn’t default just because the long defaulted. The short has a claim against the long which he will pursue.
I will sell you the S&P for $375,000 in 2 months. Two months later the S&P is only worth $350,000. I basically buy it for $350,000 and sell it to you for $375,000 making a $25k profit. The short won, answer is B. no?
i just used the elimination process to come up with “A”
Dreary Wrote: ------------------------------------------------------- > I will sell you the S&P for $375,000 in 2 months. > Two months later the S&P is only worth $350,000. > I basically buy it for $350,000 and sell it to you > for $375,000 making a $25k profit. The short won, > answer is B. no? What really happens is that the contract lays out some settlement procedure. When the settlement procedure isn’t followed by the long, the default provisions of the forward contract kick-in. The short sends a notice declaring an Event of Default and then a) Closes out the position; b) Sells any of the long’s collateral he is holding; c) Sets off any other obligations to the long party against the amount owed; d) Takes any other appropriate action which probably means filing a claim in court.