Short value of security (apr 2005 qu 1)

[maz1987]

One final question before the exam on Thursday!

Qu 1, April 2005:

Now, I'm having trouble here. I understand the method of finding the value (short or long) of a forward contract at a time t>0, but that's when we are given the value of the security at time t. We then find the difference between the two strike prices and discount it to time t.

However, in this question we are only given the price K_0 (= £98%). We are also given the price of the asset at time 0, which is £95%. So by my reckoning, the value to the investor at time t=0 is just £98%. Because that's what he's going to get paid at time t=1. Obviously that's not the answer, because nothing in the exam is that simple (oh, if only!), but I can't see why not.

Thanks

 

[John Lee]

Qu 1, April 2005:

Now, I'm having trouble here. I understand the method of finding the value (short or long) of a forward contract at a time t>0, but that's when we are given the value of the security at time t. We then find the difference between the two strike prices and discount it to time t.

However, in this question we are only given the price K_0 (= £98%). We are also given the price of the asset at time 0, which is £95%. So by my reckoning, the value to the investor at time t=0 is just £98%. Because that's what he's going to get paid at time t=1.

The way it's phrased is slightly confusing - the strike price given is actually something that was agreed before the current time.

So use the 95 to get the current strike price if the investor took out a forward contract today and then do the subtraction and discount thang.

That help?

 

[maz1987]

Completely! Thanks so much. I never would have interpreted it that way in an exam