Question

Problem 1. True or false (briefly explain why) (1) It's free to enter a forward contract when it's initiated, so the forward price is 0. (2) At the terminal time T, as a forward contract holder, you can choose not to exercise the contract. (3) As a put option seller, you are obligated to buy the underlying at time T if the option buyer wants to exercise the option.

Answer 1

(1) True: Forward contract does not require a down payment at the time of purchase, the price to sell/buy is of a future specified date. As no money is exchanged when the contract is initiated, the forward price is 0.

(2) False: A forward contract is not an option to either the parties, it's a contract that needs to be honoured. The holder of the forward contract has to exercise the contract at the terminal time T. If the holder wishes to cancel the contract then he needs to take a reverse position to his buy/sell contract but he has to honour the contract.

(3) True: A put seller is a person who undertakes the obligation to deliver the security at a predetermined price to the option buyer if the option buyer chooses to exercise such option. The holder of the option has the right to exercise such option if he may choose to do so at the predetermined date but the seller has no such right, what he has is the obligation to buy the underlying.