Consider what happens if long prepays $12 and stock rises to $58. In that case he would be due $20: $8 winning in the bet, plus $12 his prepayment that must be returned. The arrangement is cumbersome and nearly doubles long's exposure. He would not accept it.

There is a solution: Long prepays his exposure in a "reduced" forward - the original forward reduced by a Reduction Factor. The Reduction Factor for long, R_L, is the ratio of long's potential profit to the stock's price range:

Call value is the amount of prepayment of long in this reduced forward:

RL = 0.4

		Call Value = $20 - $15.2 = $4.8

Now, if the stock price rises to $58, long would make $3.2:

Long's profit = 23.20 - 20 = 58 - 50 - 4.80 = $3.2

If it falls to $38, he would owe nothing: his paypaying has given him the right to default on any additional loss. That is how a call is the right of long to default in a forward.

Click here to see put valuation, when short prepays.

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