A short forward contract that was negotiated some time ago will expire in three months and has a delivery price of $40. The current forward price for three-month forward contract is $42. The three month risk-free interest rate (with continuous compounding) is 8%. What is the value of the short forward contract?

-$1.96 is the value.

Explanation:

The contract gives obligation to sell for $40 when a forward price negotiated today would give one obligation to sell for $42.

The value of contract is present value of

40 - 42 = - $2

The rate is at 8%

8% = 0.08

3 months = 3/12 = 0.25 years

The present value can be calculated as

Value of present contract = - 2e^ (0.08 x 0.25)

Value of present contract = - $1.96