- CFA Level 2: Derivatives Part 1 – Introduction
- What are Forward Contracts?
- Equity Forward Contracts
- Fixed Income Forward Contracts
- Currency Forward Contracts
- Forward Rate Agreements (FRA)
- Credit Risk and Forward Contracts
- Introduction to Futures Contracts
- Futures: Convergence of Spot and Futures Prices at Expiration
- Futures Prices vs. Forward Prices
- Contago and Backwardation
- Pricing Stock Index Futures
- Pricing Interest Rate/Treasury Bond Futures
- Pricing Currency Futures
- Eurodollar Futures
Credit Risk and Forward Contracts
Since a forward contract is not exchange traded, a buyer or seller cannot lock in gains/losses on the contract’s value prior to the agreed settlement date. The contract must be held till its maturity.
Credit Risk Amount: Given this characteristic of forwards, the contract’s value serves as a quantification of credit risk for the counterparties involved in the contract.
Expected Loss: The expected loss on a forward contract is equal to the notional amount of the contract multiplied by the contract’s value multiplied by the probability of default.
If the contract has a positive value, then the buyer is at risk that the seller will not deliver the underlying at settlement.
If the contract has a negative value, then the seller is at risk that the buyer will not purchase the underlying at settlement.