Profit question

[ybern]

I was wondering if my understanding of the profit is right:

Let say I enter a one-year long forward with a $104 forward price and buy a zero-coupon bond at a risk free interest of 4% for $100 to get $104 in 1 year and that the spot price in 1 year is $109.

My profit would be 109 - 104 = $5

I have 2 questions:

1- Why isn't it 109 - 100 = $9?

Is it because the 4% risk free is not a profit since I would have to pay 4% as well if I would borrow the $100?

2- Would it be different if the risk free coupon would give me 5% and I had borrow $100 at 4% interest?

[jraven]

Originally Posted by ybern

I was wondering if my understanding of the profit is right:

Let say I enter a one-year long forward with a $104 forward price and buy a zero-coupon bond at a risk free interest of 4% for $100 to get $104 in 1 year and that the spot price in 1 year is $109.

My profit would be 109 - 104 = $5

I have 2 questions:

1- Why isn't it 109 - 100 = $9?

Is it because the 4% risk free is not a profit since I would have to pay 4% as well if I would borrow the $100?

You generally take time-value-of-money into account when determining profit. Given that the risk free rate is 4%, if we spend $100 at time 0 and make $109 at time 1, that makes our profit at time 1 come out to

2- Would it be different if the risk free coupon would give me 5% and I had borrow $100 at 4% interest?

It's a little strange to have two risk-free interest rates going on in a problem, since that would allow for arbitrage.