- 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
There is credit risk involved in forward contract because the counterpart may not deliver the asset to you at the time of delivery.
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.
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