So first off, im weak at derivatives, so apologises if this question seems dumb
So this example…
Assume there is a 1 year forward contract at $106 with a risk-free rate of 5%, and it is 3 months in the life of the contract. If the current spot price is $104, determine the cash flows, assuming the parties have agreed to mark to market every 3 months.
The price goes down from 106 to 104, so the long needs to pay the short right? - Guess not.
The answer is:
$104 - $106 /(1.05^9/12) = $1.81
Therefore, the short owes the long this amount. The contract will be repriced at 104(1.05)^9/12 = $107.88, and the two parties will mark to market again at the 6 month point.
if your contract had continued on till the end of the term (9 months from now) - you would have paid 106$ at the end.
So at 3 months what is the NPV of that? 106 / (1.05 ^ (9/12))
and this has to be compared with the 104$ which is the current spot price.
If you had entered into a contract now - your spot would have been 104$, and that should be compared with what you would pay 9 months from then.
another way of saying the same thing:
Now long needs to pay Short 104$ (@ spot) to buy the underlying now.
He would have paid 106 / 1.05^(9/12) if he had continued on with his forward contract he had entered into 3 months prior. This is Mark to market of the forward.
so compare the two to determine who owes whom - if 104 > 106 / 1.05^(9/12) then long pays short the difference. If 104 < 106/(1.05^(9/12)) then short pays long the difference.
and the 104 * 1.05 ^ (9/12) -> is the new forward price for a spot price of 104$.