I am a bit confused regarding the Credit Risk Exposure for forwards.
why there is no risk in this example as per the answer while there was risk borne by the short in the example that was stated in the CAFI book ( included below).
And why are we analyizing the risk from the short’s point of view?
In the CAFI example why did we divide by two different interest rates and why did we discount the current exchange rate?
A short position in a one-year forward contract with a forward price of $200 and six months remaining until expiration. The forward price was determined based on a risk-free rate of 5.5%. The current spot price of the underlying asset is $207.
The first example asks the credit risk of the short position. THe result short owes money to the long, so they have no credit risk to the short (they owe money)
The second example is asking the credit risk of the long position. Here, the short owes money to the long (similar to the first one) so there is a credit risk to the long.
Because there’s two perspectives, the buyer and the seller. You can ask if the buyer has profited and you can ask if the seller has profited. You can ask if the buyer has the credit risk or if the seller has the credit risk. THe first question wanted to know about the seller, the second question wanted to know about the buyer.
This is how you calcuate a mark to mark for forward contracts. You take the current spot, calculate the forward at the current market, and subtract the original forward… Then you discount all that back to present time. This is an L2 calcuation.
A short position in a one-year forward contract with a forward price of $200 and six months remaining until expiration. The forward price was determined based on a risk-free rate of 5.5%. The current spot price of the underlying asset is $207.