Forward vs. Outright PurchaseForward payoffBond payoff Forward + bond = Spot price at expiration - $1,020 + $1,020= Spot price at expirationPayoff ($)2500Figure2000Comparison of1500payoff after 6$10201000months of a longposition in the500S&R index versus+Longforward0+$1000bonda forward contract+Forward+bond-500in the S&R index1020-1000-102005001000150020002500S&RIndexPrice(S)
Forward payoff Bond payoff Forward vs. Outright Purchase Forward + bond = Spot price at expiration – $1,020 + $1,020 = Spot price at expiration Figure Comparison of payoff after 6 months of a long position in the S&R index versus a forward contract in the S&R index
Additional Considerations Type of settlementCash settlement: less costly and more practicalPhysical delivery: often avoided due tosignificantcosts Credit risk of the counter partyMajor issue for over-the-counter contracts?Credit check, collateral, bank letter of credit Less severe for exchange-traded contracts Exchange guarantees transactions, requirescollateral
Additional Considerations Type of settlement • Cash settlement: less costly and more practical • Physical delivery: often avoided due to significant costs Credit risk of the counter party • Major issue for over-the-counter contracts •Credit check, collateral, bank letter of credit • Less severe for exchange-traded contracts •Exchange guarantees transactions, requires collateral