Finance 30233, Fall 2014 Name____Solution_____________________

S. Mann

Sample Problem forward contract valuation

Your firm has existing forward contracts with ESSO Oil to purchase 1 million barrels of oil for
delivery at the end of March, May, and July 2015 (total forward purchase of 3 million bbl), as
the contract delivery price of $60 dollars per barrel for each month.

a) Use the following forward prices and discount factors to find the combined value today of
your contracts with ESSO.

Discount factor Forward price

Delivery Date B(0,T) F(0,T) V
3/31/15 0.99 70.00 = .99 (70.00 60.00) x 1,000,000
5/30/15 0.98 65.50 = .98 (65.50 60.00) x 1,000,000
7/31/15 0.97 63.00 = .97 (63.00 60.00) x 1,000,000

=.99 x $10.0 million

+.98 x $ 5.5 million
+.97 x $ 3.0 million

= $18.2 million

b) ESSO has offered to pay you a cash payment today in order to terminate the contracts.

i) What payment would you require?

same as (a): $18.2 million

ii) If ESSO were nearing bankruptcy, how would that influence your negotiation?
(be brief)

Looming bankruptcy weakens your bargaining position, as ESSO may not be able
to pay you and you will be an unsecured creditor in the bankruptcy proceedings (thus
unlikely to recover what you are owed). You will likely be forced to settle for less than full
value if you are able to obtain a payment at all.