Question
Assume that that the investor who wanted to default on the forward contract (which is 1.5325) indeed on day 1 decides to walk away from
Assume that that the investor who wanted to default on the forward contract (which is 1.5325) indeed on day 1 decides to walk away from the forward contract with the MM.1 To maintain a neutral position in the currencies, the MM has to find another investor (say, Chloe) to replace the walk-away investor (of course, the forward contract with Chloe should have the same notional value of 10 mil, but the price will have to be based on the spot exchange rate S1 of day 1).
1d/ What is the total profit (or loss) of the MM in these contracts (after replacement) on day 1? 1e/ What is the cost of default to the MM (i.e., the cost that stems from the replacement of the default investor)? That investor supposedly enters a new forward contract on day 1 with another MM for a better price now available on that date.
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started