Forwards Flashcards
What is a forward contract?
Contract to buy an underlying asset at a certain future date at a price specified in the contract.
What is the expiration date?
The date that marks the ends of the Forward contract.
What is the forward price?
The price specified in the forward contract for the underlying asset.
What is the spot price?
Current price of the underlying asset.
What is a cash settlement?
The difference of price between the price of the asset at the expiration date and the forward price is exchanged between the buyer and the seller without actually exchanging the stock.
Why is the profit equal to the payoff for the forward contract?
No CF before the expiration date.
What is arbitrage?
Set of transaction at no cost, that have no possibility of losses and a possibility of profit.
What is the condition to avoid arbitrage?
If two set of transaction lead to the same result, they must have the same price.
What are 3 assumptions that are made for the forward transactions?
- Possible to borrow/lend at the risk-free rate
- No transaction charges or taxes
- No arbitrage
What are the equivalences to a forward contract currency?
- risk-free rate of foreign currency = dividend rate
- risk-free rate on domestic currency = risk-free rate
- Rate at time 0 (domestic/foreign) = stock price at time 0
What is the Forward premium?
Fo,T/So
What is the annualized forward premium?
(1/T) x ln(Fo,T/So)
What is the fair value of the stock?
Price implied by the forward price when the stock market is closed.
A stock is a risky asset, with that in mind, investors expect a higher return on the asset than the risk-free rate. Compare the stock’s expected price at time T to the forward price.
Expected price of stock always > than forward price
How can you create a synthetic long forward?
Buy the asset and sell a bond (borrow money at risk free rate)
