Question

A security is currently worth N$62 million. An investor plans to purchase this asset in two years and is concerned that the price may have risen by then. To hedge this risk, the investor enters into a forward contract to buy the asset in two years. Assume that the risk-free rate is 4.75 percent. Four months into the contract, the price of the asset is N$59.2 million. Calculate the gain or loss that has accrued to the forward contract.

Answer 1

Computation of a Forward Price

Forward Price = Spot Price ( 1+i)^n

Given Stock price is Currently N$62 Million

n = 2 years

i= 4.75%

Forward price = N $ 62 *( 1+0.0475)^2

= N $ 62*(1.0475)^2

= N$ 62 * 1.097256

= N $ 68.029872

We Expect that Price will actually rise after 2 years. So we entered a forward Contract at N$68.029872 Millions.

But in actual after 2 years, the stock price fall down.

So we are incurring loss on the forward Contract.

Loss on Forward Contract = N$59.2 Million - N $ 68.029872 Millions

=  (N$ 8.829872 Millions.)

Therefore loss on the forward Contrcat is N$ 8.829872 Millions