Question
Miriam Woolrich, CFA, suggests that using forward contracts on fixed-income securities can be used to protect the value of the Redding Pension Plan bond portfolio
Miriam Woolrich, CFA, suggests that using forward contracts on fixed-income securities can be used to protect the value of the Redding Pension Plan bond portfolio against the possibility of rising interest rates. Woolrich prepares the following example to illustrate how such protection would work:
- A 10-year bond with a face value of $1,000 is issued today at par value. The bond pays an annual coupon.
- An investor intends to buy this bond today and sell it in 6 months.
- A 6-month forward contract on this bond is available, with a forward price of $1,010.60.
- In 6 months, the price of the bond, including accrued interest, is forecast to fall to $985.20 as a result of a rise in interest rates.
First, identify whether the investor would buy or sell the forward contract. Next, calculate the value of the forward contract for the investor at the maturity of the forward contract if Woolrich's bond-price forecast turns out to be accurate. Please indicate the value of the forward contract for the investor, i.e. if the investor has a short position, please indicate the value of the contract for the short position.
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