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**CFA Practice Question**

Suppose on July 1, 20X2 you enter into a forward contract to deliver 1 IBM shares with settlement date July 1, 20X3 with price $30.00 per share. There is no cash flows today. The riskless rate on July 1, 20X2 is 4.5% (six-month rate annualized). Moving on to Jan 1, 20X3 the price of IBM in the market is $32.80. The riskless rate on Jan 1, 20X3 is 6% (six-month rate annualized). What is the value of your forward contract on Jan 1, 20X3?

A. -$2.35

B. +$2.35

C. -$2.42

**Explanation:**First calculate the forward price today (July 1 20X2) to be $31.37. Remember annual rate by convention reported as twice six-month rate. Therefore, six month rate is 4.5%/2 = 2.25%. Also financial assets like shares do not incur storage costs. The long position on the forward contract gains in value. As you are short (you are going to deliver) and the asset price has risen, you have made a loss (negative value for forward contract from an initial starting zero value).

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**User Contributed Comments**
7

User |
Comment |
---|---|

arudkov |
hot they got A? |

jimmy454 |
F=30(1.0225)^2=31.37 F=32.80(1.03)^1=33.78 change = 2.42 as you are short its a loss, why isn't it C? |

sheridanla |
The question is asking for the value not the price of the forward. You have to discount 2.42 back to Jan 1 by dividing with 1.03; 2.42/1.03 = 2.35 |

Bedee |
Why do I have to compound? |

Bedee |
I checked to first compounding = 2 because of the semi-annual rate, but I didn't get the secund calculation (1,03)^1. Why not ^2? |

ConnerVP1 |
I don't get this, the price of the forward today is the same as when it was initiated: $30. Price doesn't change. The value does change. Roll forward the current price of the asset 6 months to 32.80*(1.03) = 33.784, the value at expiration of a short position is (30-33.784),= -3.784, discount this back -3.784/(1.03)= -3.67? |

Emanco |
Tough! |