in Question 1 A, they ask for the value of the forward contract at inception so V0 (0,T) I wrote zero because isn’t the value of a forward contract at t= 0 equal to Zero? We usually set it to zero so we can get the price of the forward contract. Any thoughts?
Ya the value of a forward contact at inception is zero, because if it wasnt zero, a trader could sell the forward (go short) and buy the underlying asset, thus an instant risk free profit, arbitrage keeps it at zero
that’s what I thought! But that’s not the answer in the book!
lol ped going out there giving advice without reading the question @canadiananalyst i hope you are just starting derivatives, cause this is realy easy my friend first they told you it is off market, unlike futures, forward contracts can we started with positive value to one side and negtive to the other since the price of asset is 1000 the one year forward price should be=1000*1.0675=1067.5 but since the one we examning is priced at 1100, and 1100 is not the risk free price the seller of this contract should compensate the buyer by how much ? by the pv of the difference bettwen the price it is selling for, and the price it should be selling for so (1100-1067.5)/1.0675 =30.44
correction "and 1100 is not the risk free price " ment arbitrage free price… once the seller compensates the buyer by 30.44, the arbitrage no longer exists
Ha, this question was much more detailed then I originally assumed!!
rule 1, assume nothing rule 2, assume rule 1 is correct
Thanks Gulf! I am just starting derivatives but I did read chapter 60 and I could have sworn that at t=o, we set the value equal to zero but I guess I overlooked a few things. You’re definitely right about not assuming anything. :S
btw candian if you are OKAY with math, and willing to spend time… you know the idea i told you about it should be selling for X, but it is selling for Y so the value is the diff… with that logic, you will solve every single derivatives question, be it currency, stock, continous, bond… so all those big formula you dont need to eve know them… as almost as you can use logic to arrive at the correct futures price… the value is the diff bettwen the correct and the “wrrong one” !