Question

Consider a nine-month forward contract established at rate of $50. Now the contract is three month into its life. The spot price is $49, the annual risk-free rate is 6 percent, and the underlying makes no cash payments. At month 3, what is the amount at risk of a credit loss? What is the short position's potential credit risk at month 3? Group of answer choices A) $0.905; 0 B) $0.905; 0.905 C) $0.436; 0.436 D) $0.436; 0

Answer 1

The forwards are a zero-sum game, the gain of one party is a loss to the other party. The short position holder in forward contarct will have a potential credit risk if the spot price is lesser before its maturity.

Compute the amount at risk of credit loss:

Amount at risk of a credit loss = 49 - (50/(1+6%)^0.5) = 0.436.

Here, the current spot price is lesser therefore, the short position's potential credit risk at month 3 is 0.436.

Thus, the correct answer is choice C.

answered by: anonymous