Could you please assist with this question below ( the same concept as questions 2009 AM Q9, 2015 Finquiz mock 3,Q8). Im sure this material is LII material but im stuck!
Reading 26 – Example 8
A US party goes long a forward contract on €1 denominated in dollars in which the underlying is the euro. The original term of the contract was two years, and the forward rate was $0.90. The contract now has 18 months or 1.5 years to maturity. The spot or current exchange rate is $0.862. The US interest rate is 6 percent, and the euro interest rate is 5 percent. The interest rates are based on discrete compounding/discounting. What is the value of the credit risk?
ANSWER BY CFAI:
PV (of receipt) less PV (of payment) = $0.862x(1.05)^-1.5−$0.90x(1.06)^-1.5= −$0.0235;
My problem is, Since we are at time T0.5 and the spot rate is 0.862, which i guess should be the PV, why are we further discounting this by another 1.5 years.
Reading 26 – Example 8
A US party goes long a forward contract on €1 denominated in dollars in which the underlying is the euro. The original term of the contract was two years, and the forward rate was $0.90. The contract now has 18 months or 1.5 years to maturity. The spot or current exchange rate is $0.862. The US interest rate is 6 percent, and the euro interest rate is 5 percent. The interest rates are based on discrete compounding/discounting. What is the value of the credit risk?
ANSWER BY CFAI:
PV (of receipt) less PV (of payment) = $0.862x(1.05)^-1.5−$0.90x(1.06)^-1.5= −$0.0235;
My problem is, Since we are at time T0.5 and the spot rate is 0.862, which i guess should be the PV, why are we further discounting this by another 1.5 years.