Explanation:
The option to buy X units of any asset at price P and hold them for one period or enter into a forward contract to buy one unit of the asset in one period is the correct choice. This is because both these options are economically equivalent. In the first option, the investor buys X units of the asset at the current market price and holds them for one period. This means that the investor is exposed to the risk of price fluctuations during this period. If the price of the asset increases, the investor stands to gain, but if the price decreases, the investor stands to lose. In the second option, the investor enters into a forward contract to buy one unit of the asset in one period. This means that the investor agrees to buy the asset at a predetermined price in the future, regardless of the market price at that time. This allows the investor to hedge against the risk of price fluctuations. Therefore, both these options are economically equivalent as they both involve the same level of risk and potential return.
Choice A is incorrect. This choice suggests that the investor can sell the asset at a higher price immediately after purchasing it, which is not always possible in real market conditions. Additionally, this option does not provide an economically equivalent alternative to entering into a forward contract to buy one unit of the asset in one period.
Choice B is incorrect. The time periods for holding the asset and for the forward contract do not match in this option. Buying X units of any asset and holding them for one period is not economically equivalent to entering into a forward contract to buy one unit of the asset in two periods.
Choice D is incorrect. Similar to Choice A, this option assumes that an investor can sell assets at a higher price immediately after purchase, which may not be feasible due to market fluctuations. Furthermore, it suggests buying one unit of an asset in a future period at the lowest possible price through a forward contract, which contradicts with how prices are determined in forward contracts based on current spot prices and interest rates.
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Q.1519 Forward contracts are the simplest types of derivatives and their risk can easily be calculated through basic building blocks forming those contracts. But before buying forward contracts, an investor needs to make a decision between two alternatives which are economically equivalent. The usual options available to the investor are to:
A
buy X units of any asset at price P and sell them at a higher price to potentially earn profits or enter into a forward contract to buy one unit of the asset in one period.
B
buy X units of any asset at price P and hold them for one period or enter into a forward contract to buy one unit of the asset in two periods.
C
buy X units of any asset at price P and hold them for one period or enter into a forward contract to buy one unit of the asset in one period.
D
buy X units of any asset at price P and sell them at a higher price to potentially earn profits or enter into a forward contract to buy one unit of the asset in one period at the lowest price possible.