Simple explanation for “optimal” timing of delivery on long and short foreign exchange forward contracts

In question 3 of problem set 3, If the foreign interest rate rf is greater than the domestic interest rate r, then F(t,T) is inversely related to changes in the time to maturity (T-t) of the forward contract. Thus if client buys forward but decides to receive the foreign currency sooner rather than later, then this action increases the net value of the client’s long forward position. However, the bank recognizes the incentive for this to occur and offers the contract based upon the expectation of opportunistic behavior by the client. The incentive for selling forward is the opposite – there the net value of the client’s position is higher if settlement is delayed. Similar reasoning will help you figure out the long and short incentives when r > rf (hint: if r > rf, then F(t,T) is positively related to changes in the time to maturity (T-t) of the forward contract).

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