Forward contact

CFA Level II Derivatives
#1

Can someone explain the “overall gain/loss” concept on forward contract? I understand the contract gain/loss but not the overall gain/loss on the whole trasaction

an example would be “an investor is buying an asset in 1 year, asset is worth 225 now, interest rate is 4.75. One year later asset’s price is 190, what’s the overall gain/loss on the whole transaction?” (Cfa book 6, page 47, question 4D)

to get the 1 yr forward price you do: 225 x 1.0475 = 235.687

so loss on the contract to the long side is: 190 - 235.678 = -45.687

the gain on the asset = 225 - 190 = 35

Net loss = -45.687+35 = -10.69

why is the gain on the asset is 35? Asset price dropped 1 yr later, shouldn’t this be loss on the asset?

#2

Gain b/c you can buy the asset for 35 less.

#3

The gain here is more of the amount you didn’t lose as far as the asset is concerned.

Imagine if several months ago you went into a forwards contract to sell Apple stock at 720 dollars to your buddy. Apple now trading at 435 dollars meant you have successfully protected yourself from losing 285 dollars on Apple stock.

The opposite will be the case if you had entered a contract to sell Apple stock at 720 dollars per share and due to the revolutionary icondoms, Apple now trade at 3000 dollars per share. You’d be selling at a loss of 2820 dollars which I am sure you wouldn’t be too happy about.

#4

Super! Thx