FIN4400- Futures & Options
Ch1 homework solution
1. What is the difference between a long forward position and a short forward position?
Long forward position (aka buying a forward) is an agreement to buy an asset at a certain future
time for a certain price. Short forward position (aka selling a forward) is an agreement to sell an
asset at a certain future time for a certain price.
2. An investor enters into a short forward contract to sell 100,000 British pounds (GBP) for U.S. dollars
at an exchange rate of 1.5000 USD per pound. If the contract is held to expiration how much does
the investor gain or lose if the exchange rate at the end of the contract is (a) 1.49000 and (b)
By shorting the forward the investor has agreed to sell 1 GBP for $1.50. If at expiration the exchange
rate declines to $1.49/GBP the investor would make a profit of $0.01/GBP since he is able to sell
each pound for $1.50 instead of the market rate of $1.49 at expiration. The total profit for the
contract would be GBP 100,000 x $0.01/GBP = $1,000.
Conversely, if at expiration the exchange rate increases to $1.52/GBP the investor would make a loss
of $0.02/GBP since he has to sell each pound for $1.50 instead of the market rate of $1.52 at
expiration. The total loss for the contract would be GBP 100,000 x $0.02/GBP = $2,000.
Notice shorting (or selling a forward) is like betting the underlying asset (in this case the $/GBP
exchange rate) will decline in value.
3. A trader enters into a short cotton futures contract when the futures price is 50 cents per pound.
The contract is for the delivery of 50,000 pounds. If held until expiration how much does the trader
gain or lose if the cotton price at the end of the contract is (a) 48.20 cents per pound and (b) 51.30
cents per pound?
By shorting cotton futures the trader has agreed to sell cotton at $0.50/lbs. If at expiration...