(Question 5.28 from Ed6 of book of Hull or 3.28 from Ed5)A company enters into a forward contract with a bank to sell a foreign currency for K1 at time T1. The exchange rate at T1 proves to be S1 (>K1). The company asks the bank if it can roll the contract forward untill time T2 (>T1) rather than settle at time T1. The bank agrees to a new delivery price K2. Explain how K2 should be calculatedMy answer is:the value of a short forward contract with delivery price K1 at T1 is: K1-S1 = F1if you go into a new contract with K2 at T1 the short forward contract value F2 is:K2*exp(-r*(T2-T1))-S1 = F2at T1 the contract value van F1 = K1-S1 and not zero =>K2*exp(-r(T2-T1))-S1 = K1-S1 K2 = K1*exp(-r(T2-T1))is this answer correct or did i make a think error somewhere?

nobody?

hi Kanivan,i didnt fully understand your question (i dont have my 'hull' w/me now)... if you roll over your forward contract on fx at time 0 then k2 (or forward exchange rate) is going to beS1*exp{(rd(t2)-rf(t2))*T2) where rd(t2) is domestic interest rate for the period t2, and rf(t2) is foreign interest rate for the same period.if you want to express k2 in terms of k1 you first get forward implied interest rate differential (knowing r(t2) and r(t1)), and you have k2=k1*exp(rdf(t2-t1)-rff(t2-t1)*(T2-T1)) where rdf and rff are forward irs.

Kanivan,I am also a student of math finance, and am working on Hull's book as well.I believe your analysis is right for the regular forward contract, but the question is on foreign currency, so you need to take care of the foreign interest rate.The value of the original contract to the bank at T1, S1-K1The normal forward rate for time T2 at T1: S1*exp((rd-rf)*t), where t = T2-T1For the bank to be indifferent (the new forward contract value of S1-K1 at T1), the T2 forward rate needs to be adjusted down, so the correct forward rate is,S1*exp((rd-rf)*t) - (S1-K1)*exp(rd*t)the adjustment factor is exp(rd*t), not exp((rd-tf)*t), because had the original forward contract been settled, the bank's gain from the contract would have been in domestic currency.Any one else? Thanks