CFA Level I, Derivatives – Price vs. Value of a Forward Contract – MC Question

You own a stock priced at €104, and you have a forward contract to sell the stock at €100 in one year. The risk free rate is given by 5 percent per year. What can be said about the value and the price of the forward contract?

A. The value of the forward contract is equal to €-8.76, but its price is €100.

B. The value of the forward contract is equal to €100, but its price is €-8.76.

C. The value of the forward contract as well as its price are both given by €-8.76.

 

Solution: A. is correct.

We consider

  • the value of a contract and
  • the price of a contract.

The value of a contract is equal to the amount of wealth represented by owning a contract whereas its price is one of the terms the parties agree on when creating the contract.

  1. We first consider the share price of €104 in period 0.
  2. This price will be €100 in year T.
  3. Then, there is a forward contract in period 0,
  4. it is worth 100/(1 + r + delta) = 100/(1 + 0.05 + 0) = 100/1.05 = €95.2381, because we  have a delta equal to zero, since we consider a riskless interest rate.
  5. So, again, we get €95.2381 when considering the share as well as the forward contract, i.e. the sum of both.
  6. Therefore, which number do we have to subtract from €104 to get €95.2381? The answer is €8.76.

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