Valuation of Forwards - CFA method isn't intuitive?

[cbjohn1]

Okay … I don’t really understand the “value of a forward” contract from a conceptual standpoint. I don’t understand where the formula comes from … it makes no intuitive sense to me.
Here’s an overview of the CFAI formula in a couple derivations - http://financialexamhelp123.com/mark-to-market-value-of-a-currency-forwa...
Okay, so why does this make no intuitive sense to me? I would think the market-to-market value of a forward contract would be whatever I could sell the contract for at a discrete point in time.
So let’s say I’m in a EUR receiver, USD payer 3m forward at EUR.8135/$. In 1M, spot is EUR.8170/$. EUR Rate is 3.5%, US Rate is 4$. I would say that the value of the contract to me is .8170*(1+(.035/6))/(1+(.04/6)) - .8135. on a $10M notional forward this would be EUR 28,235.76
i.e. the contract value is the 2M EUR forward less the 3M EUR forward, what I can sell my contract now less what I bought my contract for.
Why is the way that makes intuitive sense to me wrong, and how can I reconcile this with CFA’s method?

 

[S2000magician]

cbjohn1 wrote:Okay … I don’t really understand the “value of a forward” contract from a conceptual standpoint. I don’t understand where the formula comes from … it makes no intuitive sense to me.
Here’s an overview of the CFAI formula in a couple derivations - http://financialexamhelp123.com/mark-to-market-value-of-a-currency-forwa...
Okay, so why does this make no intuitive sense to me? I would think the market-to-market value of a forward contract would be whatever I could sell the contract for at a discrete point in time.

And it is. You’re absolutely correct.

cbjohn1 wrote:So let’s say I’m in a EUR receiver, USD payer 3m forward at EUR.8135/$. In 1M, spot is EUR.8170/$. EUR Rate is 3.5%, US Rate is 4$. I would say that the value of the contract to me is .8170*(1+(.035/6))/(1+(.04/6)) - .8135. on a $10M notional forward this would be EUR 28,235.76
i.e. the contract value is the 2M EUR forward less the 3M EUR forward, what I can sell my contract now less what I bought my contract for.
Why is the way that makes intuitive sense to me wrong, and how can I reconcile this with CFA’s method?

The problem is that you’re assuming that you receive the EUR/USD 0.8135 today.
You don’t. You won’t get that for another 2 months.
So you have to discount that for 2 months.

 

[cbjohn1]

yes, was missing that part … thanks
I think this all makes sense now. The link above actually does the transform from the intuitive calculation to the CFAI formula coincidentally. Maybe I should read more carefully.
Cheers.

 

[S2000magician]

cbjohn1 wrote:yes, was missing that part … thanks

You’re quite welcome.

cbjohn1 wrote:I think this all makes sense now. The link above actually does the transform from the intuitive calculation to the CFAI formula coincidentally.

It’s not a coincidence: I wrote the article.