Price Forward contract

Dear All:

FP = So (1+ Risk free) ^t

It is simply the future value of spot rate, why don’t adjust the Risk free instead of being to the power of T.

For example Rf = 10% and time to maturity is 6 month , then divide the 10% by 2 , instead of taking the power of t=1/2

Thank you so much for your time.

That… that is not how math works…

Lol ohai…

You cannot simply divide by 2, because that would not capture the compounding interest aspect.

As SKWAK88 put, if you dont raise it to the power of “T” you are missing out on the compouding interest effect. If it were just a simple simple interest then you would use the formula you suggested.

if I have 100 one year from now and the interest rate 10%. if I discount it back to present ,then PV= 100/(1+0.1). My question is that if I discount back only 6 months. so the PV= 100/(1.05) or 100/(1.1)^1/2.

Thank you so much

Hi passcfaforsure, Below is the formula and the parameters definition. So look carefully.

PV \ = \ \frac{FV}{(1+i)^n}
1. PV is the value at time=0 2. FV is the value at time=n 3. i is the [discount rate]( "Discount rate"), or the interest rate at which the amount will be compounded each period 4. n is the number of periods (not necessarily an integer)

As you can see from the above formula, from your eg. i = 10% in your case and n = 6months/12months = 0.5 in your case.

That is - if you assume 10% to be annual(12 months) => your compunding period is 12months => n = 6/12=0.5

I hope this clears your doubt.

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