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The second year's payoff has the same payoff as a one-year option, but with the strike price equal to the stock price at the end of the first year. The third year's payoff has the same payoff as a one-year option, but with the strike price equal to the stock price at the end of the second year.
Both parties could enter into a forward contract with each other. Suppose that they both agree on the sale price in one year's time of $104,000 (more below on why the sale price should be this amount). Alice and Bob have entered into a forward contract. Bob, because he is buying the underlying, is said to have entered a long forward contract.
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Its primary applications are for pricing options on future contracts, bond options, interest rate cap and floors, and swaptions. It was first presented in a paper written by Fischer Black in 1976. Black's model can be generalized into a class of models known as log-normal forward models.
This forward contract is free, and, presuming the expected cash arrives, exactly matches the firm's exposure, perfectly hedging their FX risk. If the cash flow is uncertain, a forward FX contract exposes the firm to FX risk in the opposite direction, in the case that the expected USD cash is not received, typically making an option a better choice.
Put–call parity is a static replication, and thus requires minimal assumptions, of a forward contract.In the absence of traded forward contracts, the forward contract can be replaced (indeed, itself replicated) by the ability to buy the underlying asset and finance this by borrowing for fixed term (e.g., borrowing bonds), or conversely to borrow and sell (short) the underlying asset and loan ...
Any derivative instrument that is not a contingent claim is called a forward commitment. [ 3 ] The prototypical contingent claim is an option , [ 1 ] the right to buy or sell the underlying asset at a specified exercise price by a certain expiration date; whereas ( vanilla ) swaps , forwards , and futures are forward commitments, since these ...