Explanation
A forward contract has a fixed forward price that is agreed upon at inception and remains constant throughout the life of the contract. However, the value of the forward contract changes over time as market conditions change.
Key Concepts:
- Forward Price: The price at which the underlying asset will be bought/sold at expiration. This is fixed at contract initiation and does not change.
- Forward Value: The current worth of the contract to the long or short position. This value fluctuates as:
- Spot price of the underlying asset changes
- Interest rates change
- Time to expiration decreases
- Dividends or other carrying costs change
Why Option A is Correct:
- Constant price: The forward price is fixed and does not change over the life of the contract.
- Variable value: The value of the contract changes as market conditions evolve.
Why Other Options are Incorrect:
- Option B: Incorrect because the forward price is constant, not variable, and the value is variable, not constant.
- Option C: Incorrect because while the value is variable, the forward price is constant, not variable.
Real-World Example:
If you enter a forward contract to buy 100 shares of XYZ at $50 in 6 months:
- The forward price remains
$50 (constant)
- If XYZ's spot price rises to
$55 after 3 months, the value of your long position becomes positive
- If XYZ's spot price falls to
$45 after 3 months, the value of your long position becomes negative
The forward price stays at $50, but the contract's value changes with market movements.
