# SAMPLE #3, Credit risk of forwards

I know this type of question was already discussed. But it’s still unclear for me. Q24 Why did they calculate Forward price if actuallly the original price of forward is given (200) ??? So they calculate Forward value for Long in such way: Forward price = 200 x 1.055 = 211 (???). The long forward contract’s value is \$205 (current price of underlying) - \$211 / (1.055)^0.5 or -\$0.4264 Where is the trick ?

because of one of the following reasons: a. it is a mistake b. we are missing something from the question´s text, and actually they never entered long the fwd at 200

thank you, Hala Are there any explanation of such problem in Schweser (I don’t have books for this year) ?

not sure about schweser but in page 47 of the cfa book covering this there is one clear example where not only they say that potential credit risk = value of the fwd, but they do calculate it “correctly”

yes, I saw it, but I would say it’s even more unclear example than Sample They calculate original FP because it’s unknown at first -agreed…but what they do with dicsounting then and negative sign it makes it even more compicated…

Any conclusion to this? If: 1. This is ignored: The forward … “WITH UNDERLYING ASSET PRICE OF \$200”, and 2. The rest remains, ie. Rf =5.5%, forward originally priced \$200, 6 months remaining now, underlying asset now \$205 Then this is correct? Potential credit risk now = 205 - 200/ (1.055^0.5) = 10.28 and is borne by the long side of the forward comments?

sticky Wrote: ------------------------------------------------------- > Any conclusion to this? If: > > 1. This is ignored: The forward … “WITH > UNDERLYING ASSET PRICE OF \$200”, and > > 2. The rest remains, ie. Rf =5.5%, forward > originally priced \$200, 6 months remaining now, > underlying asset now \$205 > > Then this is correct? Potential credit risk now > > = 205 - 200/ (1.055^0.5) > = 10.28 > > and is borne by the long side of the forward > > comments? The only way I can make sense of this is that the underlying asset price when he bought it was 200, note that this is not the price of the forward, so you had to solve for the price of the forward. Kinda like if a bond was priced dirty, you agreed to buy a 10% bond in a year and the bond is currently at 100, so in one year the bond’s price should be 110. 6 months later the bond is now quoted at 104.50, but according to the forward you bought the bond should’ve been worth 105 already. just my 0.02.

thetank Wrote: ------------------------------------------------------- > The only way I can make sense of this is that the > underlying asset price when he bought it was 200, > note that this is not the price of the forward, so > you had to solve for the price of the forward. > Kinda like if a bond was priced dirty, you agreed > to buy a 10% bond in a year and the bond is > currently at 100, so in one year the bond’s price > should be 110. 6 months later the bond is now > quoted at 104.50, but according to the forward you > bought the bond should’ve been worth 105 already. Hmmm… that means the contract was NOT originally priced at \$200, but \$211. This seems to be “in synch” with the solution. That’s not bad wording with question, it’s completely WRONG wording! But thanks, thetank!

My guess is that you paid 11 bucks upfront as prmium for the forward. Remember that forward can be customized. BTW, if there were an answer around 10, i would choose. Since all the answers are so small, it made think twice.

sticky Wrote: ------------------------------------------------------- > thetank Wrote: > -------------------------------------------------- > ----- > > The only way I can make sense of this is that > the > > underlying asset price when he bought it was > 200, > > note that this is not the price of the forward, > so > > you had to solve for the price of the forward. > > Kinda like if a bond was priced dirty, you > agreed > > to buy a 10% bond in a year and the bond is > > currently at 100, so in one year the bond’s > price > > should be 110. 6 months later the bond is now > > quoted at 104.50, but according to the forward > you > > bought the bond should’ve been worth 105 > already. > > Hmmm… that means the contract was NOT originally > priced at \$200, but \$211. This seems to be “in > synch” with the solution. That’s not bad wording > with question, it’s completely WRONG wording! > > But thanks, thetank! yes the wording is terrible, and I got this wrong too. But I was wrong to think that I’d be able to purchase something a year from now at it’s current price, time value of money! So this is a lesson well learned.

Yea the \$11 is the premium paid (think of a call option prem) for the \$200 strike. So the implied strike is 211 and discount that by the (1+rfr) xy T --> gets your negative value

Ferrari321 Wrote: ------------------------------------------------------- > Yea the \$11 is the premium paid (think of a call > option prem) for the \$200 strike. > > So the implied strike is 211 and discount that by > the (1+rfr) xy T --> gets your negative value hmmm… I won’t suggest thinking this as an option. Very different to me. eg. you can lose from the forward contract.

I think the question was worded incorrectly. Sticky I got to your 10.28 answer but couldn’t believe the difference in the options. I sent them feed back about it, don’t know if they will look at it.