Lesson 15: Variations on the Forward Concept

Question 1

Prepaid forward

Answer 1

same as a regular forward, except that the payment is made at t = 0

Question 2

4 ways to obtain a stock by time T

Answer 2

1. Fully leveraged purchase: buy the stock and borrow its price, pay the loan at time T
2. Prepaid forward: buy a prepaid forward on the stock expiring at time T
3. Outright purchase
4. Forward

Question 3

Futures

Answer 3

• a futures contract is an exchange-traded forward contract, at expiry, the purchaser of a futures contract will have received over the life of the contract the excess of the underlying price over the forward price

Question 4

Differences between a futures and a forward

Answer 4

1. Futures contract: standardized contract trading on exchanges vs Forward contract: customized agreement between a buyer and a seller
2. Futures trade on markets -> the markets impose price limits
3. Futures trade on markets -> liquid
4. Futures contracts are marked to market
   + every day, the increase in price is credited to the purchaser and the decrease in price is charged to the purchaser
   + -> parties to the contract must maintain margin accounts that are credited or debited daily
   + margin accounts earn interest -> the purchaser earns or pays interest on increases or decreases in price
5. Daily settlement, margin accounts -> reduce credit risk

Question 5

Initial amount of margin

Answer 5

is a percentage of the notional value (notional value is the value of the assets underlying the contract)