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16 April, 14:17

A short forward contract that was negotiated some time ago will expire in three months and has a delivery price of $40. The current forward price for three-month forward contract is $42. The three month risk-free interest rate (with continuous compounding) is 8%. What is the value of the short forward contract?

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  1. 16 April, 16:34
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    -$1.96 is the value.

    Explanation:

    The contract gives obligation to sell for $40 when a forward price negotiated today would give one obligation to sell for $42.

    The value of contract is present value of

    40 - 42 = - $2

    The rate is at 8%

    8% = 0.08

    3 months = 3/12 = 0.25 years

    The present value can be calculated as

    Value of present contract = - 2e^ (0.08 x 0.25)

    Value of present contract = - $1.96
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