has anyone else using Qbank noticed any contradictions in the qbank answers regarding forward contracts? This was pretty frustrating for me as I was going through. Here are two examples I’ve found…(note: i’m primarily using schweser for studying and maybe I should use CFAI for this section). The price of a forward contract: a: is determined at contract initiation I’ve also had the exact same question asked and the answer was: is the settlement price for the underlying asset. (the explanation also says that this is the difference between settlement price and forward contract price) I’m having a difficult time understanding how both of these are correct. At initiation no cash changes hands (easily understandable). but wouldn’t the price not be able to be determined until settlement (when cash actually does exchange hands)? The text talks about valuing forward contracts prior to settlement but that is a “value” not a price paid to or by either party prior to settlement. I’m viewing price as a “transaction price” or a cost to the seller/purchaser at settlement. I must be wrong in my perspective. Can anyone help demystify this concept for me?
derivatives! stay away from me!!
Have you read about off-market forwards?
I realize its copyright material so you can’t post the exact questions but I think this is what its getting at: 1) At the beginning with a forward you lock in your price for something (really anything) 2) At the END of the forward, you really don’t want to have to exchange the underlying asset, so one party pays the other party the gain/loss on the forward contract. So you enter a forward contract to exchange 10 USD for 1 CAD in 100 days. TODAY you locked in the price of the exchange 10 for 1. In the future, you really aren’t going to deliver 10 dollars and get 1 CAD back. You will likely to agree to settle in US dollars. So the difference between the spot and your forward at expiration is equal to the amount one party pays the other. Practical way to remember. You own a business you plan to get a wire transfer from a foreign customer in 90 days for good you delivered today. Immediately, your bank converts at the spot when you get paid. So really, you get dollars but you just don’t know how much. You enter a forward agreement to hedge the currency risk. You are not going to have to deliver all of the foreign currency to exchange (not efficient), you are just going to settle for the difference between spot and forward. You currency gain/loss will match what you pay/receive on forward. So now it may make sense. You locked in your price at initiation but money actually paid between parties is determined at settlement date for forwards (no mark to market). Hope that helped and didn’t make things more confusing.
Chuckrox08 - I haven’t read anything about off-market forwards…how is that different than a “vanilla” forward? stingreye - I’m no more confused than I was when I started. I see the point you are trying to make, but I’m still a little confused. After thinking about it for a while I think the question was pretty poor on schweser’s part. There should have been some distinction between the two questions. edit: the only other conclusion I could come to was that one of the questions was actually referring to the “forward price” which is determined at initiation.