Question

An investor enters into a short 3 months’ forward contract to sell 100,000 British pounds for US dollars. Table 2 Spot and forward quotes of the USD/GBP exchange rate Maturity Bid Offer Spot 1.2732 1.2736 1-month forward 1.2746 1.2751 3-month forward 1.2772 1.2777 1-year forward 1.2883 1.2889 Use Table 2 to indicate how much does the investor gain or lose if the exchange rate at the end of the contract is (a) 1.25 (b) 1.30 (c) Explain what is meant by a short sell the asset.

Answer 1

a) Exchange rate at the end of the 3 months’ forward contract is $1.25/GBP
US dollars receivable at spot rate after 3 months	1.25*100,000	$ 125,000
US dollars actually received at forward rate	1.2772*100,000	$ 127,720
Gain to investors		$ 2,720

b) Exchange rate at the end of the 3 months’ forward contract is $1.30/GBP
US dollars receivable at spot rate after 3 months	1.30*100,000	$ 130,000
US dollars actually received at forward rate	1.2772*100,000	$ 127,720
Loss to investors		$ 2,280

c) Short selling is an investment and trading strategy which can be used for heding purpose also against the downside risk of a long position in an assets. An investor go for a shoet selling of an asset if he has believe that the price of such asset will decline in future.In short seeling the investor/trader will loss the money if the value of underlying asset increases and that is the reason that risk in short selling is unlimited.