can someone explain to me when we adjust the forward contract by multiplying it by 1 + risk free versus dividing it by 1+ risk free rate (example on page 264 divides), but i have also seen it adjusted first
i am confused on this
Draw a time line
Original Contract
Spot ---------------------------------------Forward after 1 year
…105
4 months later
spot
108
Value of contract = 108 - 105/(1+rf)^(8/12)
This is settled now. If value is positive - Short pays long, If value is negative - Long pays short.
This is the mark to market step.
Now a new contract is signed up at 108 * (1+rf)^(8/12)
when do we use the forward price given vs first calc the forward price and then putting into above formula?
depends on statement of the problem.
If they told you Spot = 100, rf = 5%, getting into a forward contract for one year…
need to calculate F = 100*1.05 = 105
If they told you “entered into a forward contract at 105 4 months ago. Currently underlying is worth 109… rf = 5%”
no need to find F. They gave it to you. Now you need to determine value = 109 - 105 / 1.05^(8/12)
ok - perfect, thanks