Please add some comment. why it is the case.
Suppose that the price of the forward contract for the Treasury bond was negotiated off-market and the initial value of the contract was positive as a result. Which party makes a payment and when is the payment made?
A) The short pays the long at the maturity of the contract. B) The long pays the short at the maturity of the contract. C) The long pays the short at the initiation of the contract.
Your answer: B was incorrect. The correct answer was C) The long pays the short at the initiation of the contract.
If the value of a forward contract is positive at initiation then the long pays the short the value of the contract at the time it is entered into. If the value of the contract is negative initially then the short pays the long the absolute value of the contract at the time the contract is entered into. (Study Session 16, LOS 54.a)
that’s what it is, you pay at initiation to settle the difference. It is rather tricky to know who pays who, so I hope there will not be a question like that.
Dreary, it’s very straight forward :
if the contract has a initial value, you know the long will pay this value to get in the contract since the value of a future should be 0 at initiation.
the short won’t let you enter a forward for nothing if he is already losing in the position at initiation. So you pay him the value of then contract, then at the end the long and the short settle the contract. if there were no movement of the underlying, then the short would repay the initial stake since it was already valuable for the long part.
if the value was negative, the long will receive a payment at initiation since the contrat is already a losing contract.
… makes sense. It is same as 30 days later when the contract is valued, if its value is +$100, then the owner, the long guy, has already made a gain on the contract. If someone wants to buy the contract at that time, they would have to pay $100 to the original owner (the long guy) to obtain the contract and go long. Perfect.
exactly.
it’s like buying a stock worth 10$. i wont give it to you for 0. 