Forwards Credit risk with passage of time

H

hiteshsavanth

New member
Joined
Jun 18, 2026
Messages
0
Reaction score
0
Schweser says: “the more time that passes from initiation of the contact, the greater the opportunity for conditions to change and create significant gain and credit risk for one counterparty”….. Seems the opposite to me.. Can someone help me please!
 
Individuals/Institutions are exposed to counterparty risk when they are a party to a forward contract. However, it is assumed that all institutions conduct some type of credit analysis before they enter into a forward contract, hence counterparty risk is fairly low at the beggining of the contract, however as time progresses, the credit profile of the counterparty can deteriorate as payment becomes due, thus the counterparty can default at settlement.
 
^ to add, the risk arises from the the institution being unable to collect or act on the forward agreement they have with the counter party. They very well may know the counterparty’s financial conditiion has changed but it’s difficult or costly to mitigate once it occurs.
 
you agreed to pay 10$ on a forward contract. But at the time of expiration - say the underlying is only worth 5$. Why would you pay the 10$? You would renege on your forward and buy the underlying in the open market.
in addition to that - the timing might cause conditions of the counterparty to have changed (as Galli points out above).
 
At any point during the time that you are in a forward, the spot price could move in your favour; if it does and the counterparty defaults or doesnt deliver the asset to you, you won’t see your gains materialize.
Lets say you entered a three month forward contract today on an asset at the forward price of $50 (i.e. you promise to buy this asset from the counterpart at $50 in three months). Over three months the asset price slowly went up to $80. This means that the value of your forward contract has slowly increased after three months (Spot price minus Forward price, 80 minus 50 = $30 gain). At any point during those three months, market conditions have changed, driving up the value of the forward which is in your favour (driving the value down for your counterparty - zero sum game). The forward is not traded on an exchange and hence is just a contract between you two, so if the PV of the forward is positive for you and the counterparty doesnt want to pay you are isnt able to pay you, you lose.
 
With the exception of options, credit risk at inception equals zero. With passage of time it will most likely increase (might fluctuate between the counterparties though)
 
Thanks investmentrookie, galli, cpk123, arigolden and audacious!
I think I was trying to view it, only w.r.t ‘time’ per se. Seemed like more time I have helps in greater chances to recover from losses. Point now driven home!
 
You must log in or register to reply here.
Back
Top