Suppose you sell a three-month forward contract at $35.One month later,new forward contracts with similar terms are trading for $30.The continuously compounded risk-free rate is 10 percent.What is the value of your forward contract?
A)$4.96
B)$5.00
C)$4.92
D)$4.55
E)none of the above

Question

Quizplus · Accepted Answer

First, we need to calculate the present value of the forward contract using the continuously compounded risk-free rate:

PV = 35e^(-0.1*3/12) = 33.98

After one month, the new forward contracts are trading for $30, but we already sold our contract for $35, so we have gained a profit of $5. However, we need to discount this profit back to the present value using the continuously compounded risk-free rate:

Profit = $5e^(-0.1*2/12) = $4.92

Therefore, the value of our forward contract is:

Value = PV + Profit = $33.98 + $4.92 = $38.90

But since we sold the contract for $35, our net gain is:

Net Gain = Value - Sale Price = $38.90 - $35 = $3.90

Therefore, the correct answer is C) $4.92, which is the present value of our anticipated profit.

Suppose You Sell a Three-Month Forward Contract at $35