Forward Contract and Credit Risk

CFA Level II Derivatives
#1

One of the mocks asks the following:

Kwon asks Parisi, “Will there be any credit risk associated with this forward position?”

Parisi responds with the following statement:
“You will not be exposed to credit risk at the inception of the contract or at expiration after the contract is marked to market and settled. Between dates when the contract is marked to market, you face credit risk if the price of the forward contract rises above the price at the inception of the contract.”

Kwon has entered into a short-forward contract. If the price of the contract rises above the price of the contract at inception between dates when the contract is marked to the market, it is Kwon’s counterparty that is exposed to credit risk, not Kwon. Kwon is exposed to credit risk if the price of the contract falls below the price of the contract at inception.

  1. In his response to Kwon, Parisi is least likely correct with respect to credit risk:
    A. at contract expiration.
    B. when the contract is initiated.
    C. between marked-to-market dates.

The answer was C. How is Kown’s counterparty risk that is exposed to the risk? I mean if Kwon has a short forward contract, wouldn’t be at risk if the forward price raises above the original price?

#2

No.

His counterparty would be, however. I don’t trust Kwon.

#3

but usually, if someone has a short position, are they not bearish?
so if the forward price goes up, its bad for them

I think that’s where my confusion is

#4

Yes: it’s bad for them, and they’ll want to rescind their sale.

In the vernacular, that’s known as a default.

If Kwon defaults, his counterparty loses.