Reading 52: pricing and valuation of forward contracts and for an underlying with varying maturities

Question 1

Two parties agree to a forward contract to exchange 100 shares of a stock one year from now for $72 per share. Immediately after they initiate the contract, the price of the underlying stock increases to $74 per share. This share price increase represents a gain for:
the buyer.
the seller.
neither the buyer nor the seller.

Answer 1

If the value of the underlying is greater than the forward price, this increases the value of the forward contract, which represents a gain for the buyer and a loss for the seller. (LOS 52.a)

Question 2

The forward rate F2,3 represents the interest rate on a loan for the period from:
year 2 to year 3.
year 2 to year 5.
year 3 to year 5.

Answer 2

F2,3 is the 2-year forward 3-year rate, covering a period that begins two years from now and extends for three years after that. (LOS 52.b)

Question 3

Given zero-coupon bond yields for 1, 2, and 3 years, an analyst can least likely derive an implied:
1-year forward 1-year rate.
2-year forward 1-year rate.
2-year forward 2-year rate.

Answer 3

The forward rate F2,2 extends four years into the future and cannot be derived using zero-coupon yields that only extend three years. From zero-coupon bond yields for 1, 2, and 3 years, we can derive implied forward rates F1,1, F1,2, and F2,1. (LOS 52.b)