Overall Gain or Loss on Forward

CFA Level II Derivatives
#1

This question is really frustrating me.

I have a question from my study guide on forward contracts.

Some guy enters into a contract to buy stock X at 98 dollars, it’s currently worth 95 dollars (I’m rounding the numbers). The no arbitrage foward price is 98 dollars. At expiration of the contract the asset is worth 100 dollars and the foward is worth 2 dollars. Ok that makes sense.

But then the next question asks what the "overall gain or loss to the long position on the entire transaction (spot and forward combined) is, and it says that it’s a net loss of 3 dollars. It explains this as a gain of 2 dollars on the forward, and a loss of 5 dollars on the spot.

Where does this loss of 5 dollars come from? It said “we calculate this as 100-95”…but why? If the stock was worth a million dollars at experience would there be a loss of 1 million and 5 dollars? How is the underlying asset going up in value a bad thing in any way for the long position when they are going to buy the asset at 98 dollars at expiration?

#2

CFA Institute has a really weird way of looking at this situation.

Their position is (evidently) this: the guy was going to buy the stock anyway. By going with the forward, he paid an extra $3 ($98 − $95). That’s the answer. The loss of $5 is the forsaken gain he could have gotten if he’d bought at $95.

It’s all silly.

#3

That is an odd way of looking at things. Glad I’m not just going crazy. I’ll file that in my brain under “just remember how it works, don’t need to understand the logic”.

#4

I’m not certain that that’s been established.

wink

#5

Touche. Need a larger sample size.