Subject 2. The Concept of Pricing vs. Valuation

The value of a forward, futures and swap contract is zero at initiation date. Its price is the fixed contract price. Both price and value are relevant in determining the profit for both parties.

Example

Two parties agree to a forward contract to deliver a zero-coupon bond at a price of $97 per $100 par in 3 month.

At initiation date:

  • Value: 0
  • Price: $97

At the contract's expiration, suppose the underlying zero-coupon bond is selling at a price of $97.25. The long is due to receive from the short an asset worth $97.25, for which a payment to the short of $97 is required.

  • Value: $0.25
  • Price: $97

User Contributed Comments 3

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jiba: The example given in the textbook is wrong. No rational investor will never hold a stock priced at $102 today, and buy a forward contract to sell it at $100 one year from now. Why would the investor sell the stock now and deposit the $102 in the bank? In one year the investor would get $102 + risk-free interest.
niuniucow: what if, it is probable that the stock price will fall below $100.So forward contract is wise enough here and with in a year investor can earn a interest of $4.08. depositing some where else for risk free rate.
Memeteau: Jiba. The assumption of textbook is just that an investor owns a stock and a forward contract at t=0. Then, they give us a way to differentiate forward contract value at that time and its fixed price at initiation . To determinate V0, you have to assume the hedging. Never mind that the investor is rational or not.