What is the difference between Marking to Market a Forward, and calculating the value of a Forward to a long/short? Those sound like the same thing…but my understanding is that they are completely difference topics? Calculating the value is the So-Fo/1+rf section. Marking to Market is Schweser Book 2, where you calculate the pip 1/10,000 etc and add to forward…
Why are these conceptually different?
When you’re marking to market a forward you use this formula:
[(FPspot - FPt) * NP]/(1+rp(T-t/360))
Rp = price currency rate
Calculating a forward value you use: F(0,T) = S*[(1+Rp)/(1+Rb)]
This I know, thanks - what I’m nervous about is CFA questioning our application. For Exampe, John Doe would like to know the value of his contract so he can mark it to market. These are 2 seperate answers, correct? Why are they seperate, and how can we differentiate what they are asking?
So far, what I think is the main difference, is that in a mark to market, you actually CLOSE out the forward ( take the value to you and make an offsetting trade) - can anyone with knowledge on this chime in please?
…so if CFA says simply value, it’s value formula. If they say the long has value and would like to close the contract to capture the value, then you use mark to market formula…?
Market to market is Econs topic and they must give you the bid AND the ask prices to compute the value.
Value of currency forward in is Derivatives topic, you use cost-of-carry model to compute the value.
@stunnerrunner, the formula you listed there is no-arbitrage PRICE of FX forward formula.
You technically only mark to mark futures contracts, not forwards.
When you mark to market you actually settle the gain or loss of the contract throughout the period. So if on Monday you had a $10 gain, that night the gain is settled and there is technically an additional $10 in your account. If on Tuesday it loses $20 then it is taken out of your account. This is why futures require margin accounts so they can make sure you will meet mark to market requirements.
Now if this were a forward contract, you wouldn’t mark to market. Instead you would calculate the total value up until this point. So if we use the same example as above… On tuesday the value of the forward contract would be the combined gain of 10 and loss of 20, equating to $-10 (I didn’t include discounting or anythign like that in order to simplify the example). Even though you have a -$10 you don’t actually have to pay out the $10 like you do on a mark to market futures contract.
This is why American options are more valued than European options for futures contracts when compared to forward contracts.
If the futures contract has a gain of 1,000 and you execute the american option, you immediately get the contract, mark to market the $1,000 gain and can earn interest on your $1,000. While with a European option you cannot exercise early. As with forwards the American option is considered to be equally valued because you cannot mark to market a forward and thus if you had a $1000 gain on a forward it wouldn’t matter as you would still have to wait until the VERY END of the forward contract to realize the gain and start earning interest on it.
Hope that helps and is clear enough
@SWhip You can actually MTM forwards. I believe MTM has several meanings, but in this context, you MTM forwards for accounting purposes, NOT to cash out your gains in a clearing house.
Technically, you don’t mark to market forwards as a matter of course, but you can certainly agree to do so.
@Xander & S2000. Yes you both are right, I should have switched “technically” to “generally.”
You can mark to market for accounting purposes. Also as S2000 said, parties will sometimes agree to mark to market forwards and one of the benefits results in reduced credit risk.
so we will calculate value of forward/swap etc and then exahnce value and now value becomes 0?
this is right ?
You calculate the price of forward/swap, that is, the no-arbitrage price that will make the value of the forward/swap contract zero at contract initiation.
When we mark to market for Forward contract, we would calculate as:
=> (Ft - F0) / (1+Rf)T-t
When marking to market for Future contract, we calculate as:
=> Current future price - Previous settlement price
Therefore, why is marking to market for Future contract not discounted back as Forward contract? What is the difference?
When we mark to market for Forward contract, we would calculate as:
=> (Ft - F0) / (1+Rf)T-t
When marking to market for Future contract, we calculate as:
=> Current future price - Previous settlement price
Therefore, why is marking to market for Future contract not discounted back as Forward contract? What is the difference?
The difference is the timing of the cash flows.
Mark-to-Market for a Forward Contract - the net cash flow is set to occur in the future, on the settlement date of the original contract so since it’s a future cash flow, it’s discounted back.
Marking to Market for a Futures Contract - cash flows occur daily until the settlement date of the original contract so there is no need to discount.