Your bank has entered into a forward to buy one million ounces of gold from a mining company in two years for $1,500/oz. The current forward price is $1,600; the risk-free rate is 5% per year, the recovery rate is 30%, the volatility of the forward price of gold with two-year expiry is 20%. Defaults can happen in the middle of each month. The default probability during the first year is 0.001667 per month and the default probability during the second year is 0.0025 per month. 

What is the value of the forward contract after the possibility of defaults has been taken into account?

Answer rating: 100% (QA)

To calculate the value of the forward contract after considering the possibility of defaults we need to estimate the expected cash flows and discount ... View the full answer