B DESCRIBE THE PROCEDURES FOR SETTLING A FORWARD CONTRACT AT EXPIRATION, AND HOW TERMINATION PRIOR TO EXPIRATION CAN AFFECT CREDIT RISK;

Question 1

DESCRIBE THE PROCEDURES FOR SETTLING A FORWARD
CONTRACT AT EXPIRATION, AND HOW TERMINATION PRIOR
TO EXPIRATION CAN AFFECT CREDIT RISK;

Answer 1

Settlement (settling, terminate) and Early Termination
• Forward contracts can be settled by:
 Physical delivery
 Cash settlement
• Exiting the contract early can be difficult.
 Negotiate an exit with the counterparty (Whenever you add a party to a two party, you’re adding a credit risk)
 Enter into another contract with opposite terms
Now there are 2 sources of credit risk!

Question 2

The procedure for settling a forward contract at expiration

Answer 2

re-enter the market and create a new forward contract expiring at the same time as the original forward contract, taking the position of the seller instead and pray to God the Long stays in and the short doesn’t defaut.

Question 3

How Termination prior to expiration can affect credit risk

Answer 3

Counter-party (long) on short fails to pay, thus exposing short to the risk of changes in assets price.