Final answer:
At inception, the fair value of a forward contract is usually zero. By the end of the reporting period, it's determined by the present value of the difference between the forward and market prices. At settlement, fair value converges to zero as the contract closes.
Step-by-step explanation:
The fair value of a forward contract is a measure of what it would cost to close out the contract at a point in time, which can differ at inception, at the end of the reporting period, and at the settlement date. At the inception date, the forward contract's fair value is typically zero because the contract is created with terms that reflect the market conditions at that time, so there's no inherent gain or loss.
At the end of the reporting period, the fair value is determined by the present value of the difference between the contracted forward price and the current market price of the underlying asset. If the market price is higher than the forward price for a purchase contract, the fair value will be positive, indicating a gain; if it is lower, the fair value will be negative, indicating a loss.
On the settlement date, the fair value of the forward contract converges to zero as the contract is settled. The value of the settlement is based on the contracted forward price, not on the market price of the underlying asset at that time.