A characteristic of forward commitments is that they:
A provide linear payoffs.
B do not depend on the outcome or payoff of an underlying asset
C provide one party the right to engage in future transactions on terms agreed on in advance.
A is correct. I do get why C is incorrect (forwards do not give the right but they obligate both parties to respond to their commitments). But i’m not sure about B…
To me a forward commitment has nothing to do with its underlying’s performance, unlinke an option, on a forward contract you have to pay a specific amount regardless of how the underlying performs. Can someone give their insight here?
I have no idea what the author of the question means by the phrase, “they do not depend on the outcome . . . .”
For example, does that mean that the value does not depend on the outcome?
It’s a poorly worded question.
The usual inquiry: where did you get this question?
Hey S2000magician, thanks!
CFA official book, R48 EOC 8.
I guess the author was talking about the value of the contract then… because in fact, your forward PnL will depend on the underlying asset’s closing price, but that’s it. Yeah, quite confusing.
My pleasure.
I get so tired of poorly worded questions.
What the CFA Institute explanation is describing is a market forward contract; i.e., one in which neither party has an upfront payment.
However, forward contracts are custom agreements; the parties can negotiate anything they want to. If they want to negotiate a higher forward price, they can. It should result in the short paying the long (at the inception of the forward) the present value of the difference between that price and the no arbitrage price, but if they’re OK with that, then why not? (Such an agreement would be deemed an off-market forward contract, by the way.)
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Thanks a lot S2000magician, i finally got this notion of forward price and value of the forward at 0 (thus, no upfront) at the date of initiation… Never understood until you pointed out this distinction of a market forward that i never seen previously in my experiences. I’ve seen, forward contracts with predetermined prices that had nothing to do with the current spot price (either superior or inferior to the spot price of the underlying). I guess a “forward commitment” in CFA’s definition is always a market forward contract.
I agree with you both. I am flabbergasted with the quality of questions floating around everywhere. Poorly worded, embedding wrong concept or simply subjective interpretation that flirts with the underlying concept itself. And I am astonished that some of them simply emanate from the CFAI text themselves
These snippets are like bugs. Once they enter ones intellectual stream they not only muddle the rational thinking but also potentially destabilise ones future learning.
In a forward commitment either party could default unlike a contingent claim contract where only the short could default since the long enters the contract having paid the premium. This is correct but the way it is explained beggars further confusion especially to the uninitiated who has just commenced the program.
Reason why the legendary contribution from the Magician becomes so invaluable. Such flawless lucid concept clearing only can be gleaned out by someone who not only is a Charterholder but also have worked in the real world a great length.
It is easy to hold a cat in the lap and make videos and deploy smart marketing tactics to sell ones courseware…. It is quite another to field qs. and doubts of the candidates from world over…often laded with wrong concept, courtesy those cat in the lap videos. With proliferation of prep providers ( while some are indeed quality ones ) this is bound to happen. Reason why AF or Reddit become important …albeit with a guide and a man Friday like the Magician ( and few others as well with a lesser degree of consistency)
Blofeld markets CFA videos?
Who’da thunk it?