- CFA Exams
- CFA Level I Exam
- Study Session 16. Derivatives
- Reading 49. Basics of Derivative Pricing and Valuation
- Subject 3. Pricing and Valuation of Forward Contracts

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**CFA Practice Question**

John has an asset that is worth $110. He plans to sell it in 8 months. The risk-free interest rate is 4.5%. Suppose the forward contract is entered into at $113.28, and the price of the underlying asset is $109 at expiration. What is the rate of return for John?

Correct Answer: 4.5%

- S
_{T}= 109 - V
_{T}(0, T) = V_{9/12}(0, 9/12) = 109 - 113.28 = -$4.28

^{12/8}- 1 = 4.5%.Not surprisingly, this rate is the annual risk-free rate. The transaction was executed at the no-arbitrage forward price of $113.28, and therefore it would be impossible for John to earn a return higher or lower than the risk-free rate.

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**User Contributed Comments**
6

User |
Comment |
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PhiWong |
Another way to look at it is: Since John already long the foward, he is lock in for the selling price and therefore his rate of return would be precisely the risk-free rate. |

PASS0808 |
John's return =value of the contract +return of holding the asset =-(109-113.28)+(109-110)=113.28-110=3.28 |

HenryQ |
It is better to keep the 109 out of the pictures here...it does not matter what future spot price is...it can be 104, 105, anything...it does not impact the return as it is already locked in by the contract... |

vi2009 |
As long as the forward contract is entered at the arbs-free price, the rate of return is the RF rate. |

mchu |
good question |

Shalva |
Yes, useful tip to remember - if locked to no-arbitrage price, you'll earn only RF return |