Homework Answers
Answer to question 1
A forward contract is a derivative contract by which one party agrees to buy and another party agrees to sell something on a pre-determined day at a pre-determined price in future.
It is different from a futures contract as it is not regulated through a clearing corporation and and the terms are much more flexible than future contracts.
Answer to question 2
(1) The long position will loose as it entered into a contract to buy at 22 but it is available in the market for just 21.50
(2) The exercise price is $22 as this was the agreed upon price between the two parties.
(3) At 19, the short position holder will gain (22-19) = $3 per share
At 21, the short position holder will gain (22-21) = $1 per share
At 23, the short position holder will lose (23-22) = $1 per share [Short position holder has a right to sell at 22, hence at any price below 22 he will gain and at any price above 22 he will lose]
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