Ryan Parisi is a Managing Director in the Derivatives Group at High Ridge Partners, an investment management firm. Parisi specializes in advising institutional clients on the use of forward contracts in their portfolio management strategies. Parisi is preparing to meet with three of the firm’s U.S. based clients: Leslie Sheroda, Kihoon Kwon, and David Ruane. Corey Curmaci, an analyst in the Derivatives Group, has also been asked to attend the meeting. Prior to the meeting, Parisi asks Curmaci if he is clear about how the value of a forward contract is determined. Curmaci responds,” Yes, I am. In general, the value of a forward contract may be positive or negative at the inception of the contract, during its life, and at the expiration of the contract.”

Leslie Sheroda manages equity portfolios for a pension fund. One month (30 days) ago, Sheroda had indicated that the pension fund expected a large inflow of cash in 60 days. In order to hedge against a potential rise in equity values over this period, Parisi advise Sheroda to enter into a long forward contract on the S&P 500 stock index expiring in 60 days. Sheroda has asked Parisi to calculate the value of the forward position today: that is, 30 days after the contract was initiated. Parisi has collected the information in Exhibit 1 below to carry out the valuation assignment.Exhibit 1Selected Financial Information for Sheroda Meeting

Price of a 60-day S&P 500 Forward Contract 30 Days Ago1403.22 S&P 500 Index Level Today1450.82 Annualized Continuously Compounded Risk-Free Rate3.92% Annualized Continuously Compounded Dividend Yield for S&P 5002.50% Three month ago (90 days), Kwon purchased a bond with a 5% annual coupon rate and a maturity of 7 years from the date of purchased. The bond has a face value of $1,000 and pays interest every 180 days from the date of issue. Kwon is concerned about a potential increase in interest rate over the next year and has approached Parisi for advice on how he can use forward contracts to manage his risk. Parisi advises Kwon to enter into a short forward contract expiring in 360 days. The annualized risk-free rate now is 4% per year and the price of the bond with accrued interest is $1,071.33. Kwon asks Parisi to calculate the appropriate price for the forward contract.

Kwon asks Parisi, “Will there be any credit risk associated with this forward position?”

Parisi responds with the following statement:

“You will not be exposed to credit risk at the inception of the contract or at expiration after the contract is marked to market. In between mark to market dates, you face credit risk if the price of forward contract rises above the price at the inception of the contract.”

Parisi’s next meeting is with Ruane, who is the corporate treasurer for a manufacturing firm. For the meeting, Parisi has collected the information in Exhibit 2.

Exhibit 2Selected Financial Information for Ruane Meeting

Annualized 90-day LIBOR rate3.2% Annualized 450-day LIBOR rate4.5% Annualized risk-free rate in the U.S.4.0% Annualized risk-free rate in the euro zone6.0% Spot Exchange rate $ per €1.3900 Three month (90 days) from now Ruane expects to borrow $5 million, at LIBOR, for a period of twelve months (360 days). He is concerned that interest rates may rise significantly over the next few months and wished to hedge this risk. Parisi advises Ruane to enter into a Forward Rate Agreement (FRA) expiring in 90 days on 360 days LIBOR. Ruane wants to know the rate he would receive on the FRA.Ruane also expects an inflow of €3 million that needs to be converted to $US in 270 days and is concerned that the euro will decline in value over this period. Ruane is advised by Parisi to enter into an agreement to sell the euro forward In 270 days. Ruane asks Parisi to determine the appropriate forward price on the euro.