# question on "Gain on asset in forward contract "

Referencing the practice question in Derivative book of the CFA Curriculum. Page 50, question #4. Question reads: A security currently worth \$225, investor wants to purchase the asset in 1 year and is concerned with possible rise in price of the asset. So the investor enters into a forward contract to buy the asset in one year. Rf is 4.75%. Question part D: Suppose at expiration, the price of the asset is \$190, calculated the value of the forward contract at expiration and also indicate the overall gain or loss to the intestor on the whole transaction. Answer key indicates there’s a gain on asset of \$35 (\$225 - \$190) so the net loss is -10.69 (loss for the long is -45.69=\$190 -\$235.69). Can anyone explain the gain on the asset? where did that come from? Thanks and much appreciated!

Asset today is worth 225\$ wants to purchase asset. In the forward market it is worth 190\$. If he bought the asset now - it is worth 225 If he bought it in the forward market - it is available at 190 Essentially it is an opportunity cost of not buying it today… he has to spend less to buy it in the forward market - so it is a gain (imputed) for him. But his forward is worth 235.69 (@ rf). so he has lost 190-235.69 on the purchase – since he contracted for 235.69 he would gain only if price rose above that amount. If it fell - the Short party to the transaction gains.

CP - It sounds like you have the right answer - though I think your explanation is a little confusing. P0 is 225 P1 is 190 (not P in fwd mkt) b/c the investor holds cash instead of buying the asset he/she has the imputed gain of \$35 absent entering into the fwd contract the investor did gain by not buying the asset at t=0 However, the inv. did enter into the fwd contract to buy @ 235.69 at t=1, so the transaction ends up in a loss b/c they’ll have to pay 235.69 for an asset now worth 190.

Thanks guys for the help. Much appreciated. - JD

I’m still not clear on this. The investor is still required to purchase the asset at \$235, regardless of what the market price is. If prices fall, he has a loss; if they go up, he has a gain. What am I missing here?

yeah, i don’t see the gain here either, are you sure the question is correctly translated here? I think the gain could only come if the investor shorted the asset and covered in one year with the forward (190 - 235.69 + 225 - 190) = -10.69

The “gain” here comes from NOT buying the asset at t = 0 and instead buying at t = T at the lower price. They’re doing a poor job showing that you can break down the PNL at t = T into the “change in asset price” net of cost of carry: Long’s PNL = (end price - start price) - (cost of carry) -\$45.69 = (-\$35) - (\$10.69) If you look at part E, it’s the same question but with S_T = \$240 and you’ll find that 4.31 = (+\$15) - (\$10.69) The key here is that the cost of carry is the same. Win or lose on the ultimate price, the long paying the cost of carry, i.e. is borrowing money from the short at the RFR.

but the question states you buy the asset one year from now in a forward price, so that fwd price is 235 so you have a loss. It does not state that the investor buys the asset at 190 one year from now. It appears you are long the forward and the price drops therefore you are down the forward price vs. spot at one year.

ro424 Wrote: ------------------------------------------------------- > but the question states you buy the asset one year > from now in a forward price, so that fwd price is > 235 so you have a loss. It does not state that the > investor buys the asset at 190 one year from now. > It appears you are long the forward and the price > drops therefore you are down the forward price vs. > spot at one year. But the question is asking for the gain on the asset (the underlier) not the forward contract. This is the value of the forward minus the cost of the carry.

justin88 Wrote: ------------------------------------------------------- > ro424 Wrote: > -------------------------------------------------- > ----- > > but the question states you buy the asset one > year > > from now in a forward price, so that fwd price > is > > 235 so you have a loss. It does not state that > the > > investor buys the asset at 190 one year from > now. > > It appears you are long the forward and the > price > > drops therefore you are down the forward price > vs. > > spot at one year. > > But the question is asking for the gain on the > asset (the underlier) not the forward contract. > This is the value of the forward minus the cost of > the carry. Thanks, it clicked as soon as I read that.

Thanks guys for the help. Much appreciated. - JD

just to make sure… if he did not enter into the contract, he would have an unrealized loss of \$35 (225-190). If he did enter into the contract, he would also have an unrealized loss of \$45.69. So by entering into the contract, he cut his losses down by \$10.69.