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Forward Contract Payoff Calculations

The document provides an overview of forward contracts, including their definition and key characteristics. It includes calculations for payoffs in various scenarios for both long and short forward positions, as well as examples involving currency exchange rates. Additionally, it discusses payoff diagrams and the maximum gain or loss for long and short forwards.

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anselanasrym
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10 views2 pages

Forward Contract Payoff Calculations

The document provides an overview of forward contracts, including their definition and key characteristics. It includes calculations for payoffs in various scenarios for both long and short forward positions, as well as examples involving currency exchange rates. Additionally, it discusses payoff diagrams and the maximum gain or loss for long and short forwards.

Uploaded by

anselanasrym
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

Tutorial 2

1. Define a forward contract.


• A forward contract is a customized agreement between two parties to buy or sell an asset at a specific
price
(forward price) on a future date. Unlike futures, forwards are not traded on exchanges and are settled directly
between the
2. counterparties.
If a forward contract on gold is negotiated at a forward price of $1,487 per ounce, calculate
the payoff on the maturity date
(a) to the buyer if the gold price is $1,518 per ounce and
(b) to the seller if the gold price is $1,612 per ounce

3. Suppose you enter into a long 6-month forward position at a forward price of $50. What is
the payoff in 6 months for prices of $40, $45, $50 & $55 and $60?

4. Suppose you enter into a short 6-month forward position at a forward price of $50. What is
the payoff in 6 months for prices of $40, $45, $50 & $55 and $60?

5. An investor enters into a short forward contract to sell 100,000 British pounds for U.S. dollars
at an exchange rate of 1.7000 U.S. dollars per pound. How much does the investor gain or lose
if the exchange rate at the end of the contract is (a) 1.6900 and (b) 1.7200?

6. A trader enters into a short forward contract on 100 million yen. The forward exchange rate
is $0.0080 per yen. How much does the trader gain or lose if the exchange rate at the end of
the contract is (a) $0.0074 per yen; (b) $0.0091 per yen?

1
7. (a) What does the horizontal axis of a payoff diagram represent?
(b) What does the vertical axis of a payoff diagram represent?
(c) Consider the following scenario:
Today is 1 July. Mr Tan wants to buy oil palm at a fixed price at the end of the year. Mr
Tan’s broker finds Encik Ali who agrees to trade 4 tonnes of oil palm at a
forward/delivery price of RM2,400.00/tonne. Calculate the payoff in 6 months if the spot
prices are RM2,000, RM2,200, RM2,600 and RM2800. Draw/graph the diagram of both
the long (Mr Tan) and short (Encik Ali) positions.
(d) What is the positive range for the long forward?
(e) What is the negative range for the long forward?

8. Referring to Q3 and Q4, explain the circumstances in which the maximum gain or loss
occurs.

Long Forward (Q3):


• Maximum Gain: Unlimited, as the spot price can increase indefinitely (e.g., Spot = $60 → Gain =
$10).
• Maximum Loss: Limited to the forward price (e.g., Spot = $40 → Loss = -$10).
Short Forward (Q4):
• Maximum Gain: Limited to the forward price (e.g., Spot = $40 → Gain = $10).
• Maximum Loss: Unlimited, as the spot price can increase indefinitely (e.g., Spot = $60 → Loss = -
$10).

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