I’m looking at some CFA questions and they are asking for the values of forwards under different scenarios. They make no indication that the investor is long or shor the underlying, yet when they ask for the overall gain/loss on the trade, they incorporate not only the spot - pv of forward, but also they factor in the price movement of the underlying and net the two. What am I missing? Am I supposed to assume that the investor was long or short the underlying at the same time they bought the forward? Is that an assumption I’m to make on June 7?
Thanks. My question though is do I assume that the investor holds the underlying in addition to the forward? The question does not indicate that the underlying is held, but the answer calculates the profit on the forward, and then nets that against the “profit” on the underlying, and calculates a net profit.
Why do I assume that the investor holds the underlying?
I don’t know what you mean by factoring in the price movement of the underlying and netting the two. If you can give an example, I’ll be happy to help.
Q: A security is currently worth $225. An investor plans to purchase this asset in one year and is concerned that the price may have risen by then. To hedge this risk, the investor enters a forward contract to buy the asset in one year. Assume the risk free rate is 4.75% Suppose that at expiration, the price of the asset is $190. Calculate the value of the forward contract at expiration. Also indicate the overall gain or loss to the investor on the whole transaction.
A: St = $190
F: $235.69
V: $190 - $235.69 = -$45.69
Loss to long position: -$45.69
Gain on asset: $35.00 (based on $225 - $190)
Net loss: -$10.69
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If I see -$45.69 as one of the answer choices, I’d choose that one. But they are showing the answer as -$10.69… In general, we do not assume that the underlying is owned by the investor unless it tells us so, right? thanks
In the second part, they’re not asking about the value of the forward; they’re asking about the difference between the original spot price ($225) and the forward price ($235.69). Note that the spot price at expiration is irrelevant.
The two questions are, in essence:
How much more did Bob pay by using the forward instead of merely waiting and buying in the spot market at expiration?
How much more did Bob pay by using the forward instead of merely buying in the spot market at inception?
They’re comparing what happens with the forward compared to him just buying the underlying outright, either at the inception of the forward, or at the expiration of the forward.