- A South African guy: short a two-year forward currency contract on Pound denominated in ZAR at 10.00 £/ZAR forward rate; • this forward contract expires today; • exchange rate was 16 £/ZAR when guy entered the contract; • the spot (current) rate is now 15.50 £/ZAR; 2. A south African guy: long a two-year forward currency contract on Pound denominated in ZAR at 10.00 £/ZAR forward rate; • this forward contract expires today; • exchange rate was 16 £/ZAR when guy entered the contract; • the spot (current) rate is now 15.50 £/ZAR; who bears the risk? South African guy or the counterparty? Please say why
- Counterparty (I think). If he were to sell pounds at the market rate, it would take 15.5 pounds for each ZAR he is buying. Instead he has sold it forward where it only takes 10 pounds to buy a ZAR. 2. This is the same situation isn’t it? I would guess my answer is wrong. Forex has always been my achilles heel.
He’s short on one and long on the other… Im really confused by this thingi…
First, am I right? No point in my explaining my thinking if I am wrong. : )
OK. its the South African Guy that bears the risk. you’re wrong…
Sweet! I am dead on this exam. Am I right that the SA guy will bear the risk in both cases?
Oh wait. I am an idiot. My explanation is right, but I put down the wrong party. The futures have value to the SA Guy, jsut as I described above.
I was thinking risk in terms of who had to pay, not credit risk (as in who might NOT rec).
Sorry, i dont understand your explanation…
Okay. I will try again. 1. A South African guy: short a two-year forward currency contract on Pound denominated in ZAR at 10.00 £/ZAR forward rate; • this forward contract expires today; • exchange rate was 16 £/ZAR when guy entered the contract; • the spot (current) rate is now 15.50 £/ZAR; In this case the SA guy is short the Pound (this also makes him long the ZAR just based on the fact that this is a pound/ZAR contract). When you are short forward currency contract you are agreeing to SELL the currency forward or think in the future (and buy the other currency forward). So SA guy decided to sell pounds for ZAR at 10 pounds/ZAR. At the expiration of the contract the spot is at 15.50 pound/ZAR. So let’s say that two years ago he didn’t enter the forward and now he has some investment that he has to convert from pounds to ZAR. If it was a 1,000,000 pounds he would get 1 M pound/ 15.5 = 64,516 ZAR. BUT he was a smart guy and locked in a forward at 10 pounds per ZAR, so when he converts his 1M pounds using the forward he gets 1 M / 10 = 100,000 ZAR instead. Since 100,000 ZAR is better than 64,516 ZAR he won on the forward and bears the credit risk that the counterparty won’t pay. 2. A south African guy: long a two-year forward currency contract on Pound denominated in ZAR at 10.00 £/ZAR forward rate; • this forward contract expires today; • exchange rate was 16 £/ZAR when guy entered the contract; • the spot (current) rate is now 15.50 £/ZAR; I read this wrong. I thought he was long the ZAR, but he is long the pound. Which means he will buy the pound in the future and sell the ZAR. This should be the exact opposite of my explaination above. Does that help?
- SA guy bears the credit risk. He has shorted pound and pound has appreicated. So he had benefited, which means he bears the risk 2) Counterparty — Just opposite
Agree with Amit. See my explanation above.
Perfect.
I apologize if I confused you ALP. I read the question too fast and messed up. Sorry if you wasted some time because of it.
I agree with mwvt9’s explanation…
SA guy for first case and the opposite for the other case