FRM Part I · FRM Exam Part I · Introduction to Derivatives
A portfolio manager expects to receive cash in three months and wants to lock in today's purchase price of a bond, bearing price risk until then. Which action using forwards best achieves this?
The manager will need to buy the bond in three months and is hurt if prices rise, so entering a long forward locks in the purchase price today. This is a long hedge, whereas a short forward suits someone who will sell the asset later.
- AEnter a short forward on the bond
- BEnter a long forward on the bondCorrect
- CSell the bond spot
- DEnter a short forward and buy the bond spot
Explanation
The manager will buy the bond later and fears a price rise, so a long forward fixes the purchase price. A short forward would increase exposure to price rises. Selling spot or shorting adds no hedge of the future purchase.
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