Prepaid variable forward contract is an agreement made with the brokerage firm by an executive of the firm to lock in the profut and defer the taxes on the capital gain. Predetermined number of shares is given to the brokerage firm, with the official transferring on some future date. In return the executive recieves usually 75%to 90% of the current value of the stock.
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. The investor can then use the cash advance to diversify his or her overall investment portfolio.
At maturity, if the share price of the underlying position has fallen, the investor may be required to deliver 100 percent of the underlying shares in order to repay the contract amount (if the contract is “physically settled”). If the share price has appreciated, the investor may be required to deliver only that percentage of shares (with a minimum percentage defined by the structure of the transaction) necessary to repay the contract amount. In some situations the investor may have the right to “cash settle” the trade, thereby retaining the underlying shares.
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