FORWARD CONTRACTS ON individual STOCKS
Consider an asset manager responsible for the portfolio of a high-net-worth individual. As is sometimes the case, such portfolios may be concentrated in a small number of stocks, sometimes stocks that have been in the family for years. In many cases, the individual may be part of the founding family of a particular company. Let us say that the stock is called Gregorian Industries, Inc., or GII, and the client is so heavily invested in this stock that her portfolio is not diversified. The client notifies the portfolio manager of her need for $2 million in cash in six months. This cash can be raised by selling 16,000 shares at the current price of $125 per share. Thus, the risk exposure concerns the market value of $2 million of stock. For whatever reason, it is considered best not to sell the stock any earlier than necessary. The portfolio manager realizes that a forward contract to sell GI1 in six months will accomplish the client’s desired objective. The manager contacts a forward contract dealer and obtains a quote of $128.13 as the price at which a forward contract to sell the stock in six months could be constructed.
In other words, the portfolio manager could enter into a contract to sell the stock to the dealer in six months at $128.13. We assume that this contract is deliverable, meaning that when the sale is actually made, the shares will be delivered to the dealer. Assuming that the client has some flexibility in the amount of money needed, let us say that the contract is signed for the sale of 15,600 shares at $128.13, which will raise $1,998,828. Of course when the contract expires, the stock could be selling for any price. The client can gain or lose on the transaction. If the stock rises to a price above $128.13 during the six-month period, the client will still have to deliver the stock for $128.13. But if the price falls, the client will still get $128.13 per share for the stock.