The question ask: 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. What is the current amount of potential credit risk in the forward contract position ?
The answer is : The value of the long position is $207 – $200/(1.055)^0.5 = $12.28.
Why do we discount the forward price by the risk free rate compounded to six month?
Because this is the formula for calculate the value of long position at time t. Since forwards are zero sum game, opposite prefix is value of the short counterparty. The counterparty whose value is positive bears the credit risk that another counterparty would not deliver underlying upon contract expiration. The calculations of values of forward contracts were thoroughly examined on Level 2. Why RFR is almost always used when valuing derivatives, try to Google or simply accept that is the rule.
because forward price is set at T=0.5
and current price is set at T=0
can’t compare if T are not set on equal terms. must therefore convert forward price to T=0 to enable comparison.
The one year forward has 6 month remaining, therefore, isn’t the forward price set 6 months ago.
Can we say : 207-200*(1.055)^0.5 ??
thanks everyone, i understand it