D
Daleth
Member
The notes describe a break forward as "a forward foreign exchange contract that contains an option giving the buyer the right to 'break' the agreement to exchange currencies." (Page 17.) They go on to say that, unlike options, "break-forwards fo not require a premium to be paid... as all costs are instead allowed for in the forward rate agreed at outset."
As far as I can tell this is a type two arbitrage: zero initial cost and a non-negative payoff at maturity. Regardless of how out-the-money the forward rate is, the forward costs nothing to enter (there is no premium), and can only have a positive payoff (the buyer can choose to break the agreement). Is there something that I have missed?
As far as I can tell this is a type two arbitrage: zero initial cost and a non-negative payoff at maturity. Regardless of how out-the-money the forward rate is, the forward costs nothing to enter (there is no premium), and can only have a positive payoff (the buyer can choose to break the agreement). Is there something that I have missed?