Variable Prepaid Forward Contracts

What is ‘Variable Prepaid Forward Contracts’

An agreement to give a predetermined number of shares to a brokerage firm, with the stipulation of officially transferring title at some future date. The original owner receives a high percentage of the value of the shares at the time of transfer and receives a portion of the gains at the official transferring. If there was a loss during this time period, the brokerage absorbs it.

Explaining ‘Variable Prepaid Forward Contracts’

Variable prepaid forward contracts are often used by investors to lock in their profits and defer their taxes. In return for giving the stock to the brokerage company, the investor usually gets between 75% and 90% of the current value. So the investor receives cash now, but doesn’t actually have to account for the income until the official transfer is complete. Some think this should not be allowed because technically a transfer has occurred, and should therefore be recognized for tax and regulatory reasons.

Further Reading

  • Taxing exchange-traded notes and the future of variable prepaid forward contracts – [PDF]
  • On Pricing Unconventional Prepaid Forward Contracts: Evidence from – [PDF]
  • Mortgage prepayment and default behavior with embedded forward contract risks in China's housing market – [PDF]
  • Sale or No Sale: The Taxation of Variable Prepaid Forward Contacts involving Share Lending Agreements – [PDF]
  • The economic plausibility of strict local martingales in financial modelling – [PDF]
  • Are Incentive Contract Settlements Nonevents? – [PDF]
  • Interest rate risk, prepayment risk, and the futures market hedging strategies of financial intermediaries – [PDF]
  • Autonomous and financial mortgage prepayment – [PDF]
  • Prepayment risk and bank performance – [PDF]