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Why are futures prices and forward prices different?

Why are futures prices and forward prices different?

Futures prices can differ from forward prices because of the effect of interest rates on the interim cash flows from the daily settlement. If futures prices are negatively correlated with interest rates, then it is more desirable to buy forwards than futures.

What are the major differences between forwards and futures?

A forward contract is a private and customizable agreement that settles at the end of the agreement and is traded over-the-counter. A futures contract has standardized terms and is traded on an exchange, where prices are settled on a daily basis until the end of the contract.

What are the determinants of a forward futures price?

Interest rates are one of the most important factors that affect futures prices; however, other factors, such as the underlying price, interest (dividend) income, storage costs, the risk-free rate, and convenience yield, play an important role in determining futures prices as well.

What is the theoretical price of the futures contract?

Specifically, the fair value is the theoretical calculation of how a futures stock index contract should be valued considering the current index value, dividends paid on stocks in the index, days to expiration of the futures contract, and current interest rates.

What is the difference between forward price and value of a forward contract?

Forward Value versus Forward Price The price of a forward contract is fixed, meaning that it does not change throughout the contract’s life cycle because the underlying will be purchased at a later date. The forward value is the opposite and fluctuates as the market conditions change.

What is the difference between the forward price and the value of a forward contract?

We can consider the price of the forward contract “embedded” into the contract. The forward value is the opposite and fluctuates as the market conditions change. At initiation, the forward contract value is zero and then either becomes positive or negative throughout the life-cycle of the contract.

How are forwards priced?

Forward price is based on the current spot price of the underlying asset, plus any carrying costs such as interest, storage costs, foregone interest or other costs or opportunity costs. Although the contract has no intrinsic value at the inception, over time, a contract may gain or lose value.

How are equity futures priced?

To find the value of an equity futures contract (notional value), you multiply the price of the underlying stock and the contract size. The contract size is the deliverable number of underlying shares represented in each contract. One contract often has 100 shares of the underlying stock.

What are the theories of future prices?

The Expectancy Model of futures pricing states that the futures price of an asset is basically what the spot price of the asset is expected to be in the future. This means, if the overall market sentiment leans towards a higher price for an asset in the future, the futures price of the asset will be positive.

What is the price of a forward contract?

Forward price is the price at which a seller delivers an underlying asset, financial derivative, or currency to the buyer of a forward contract at a predetermined date. It is roughly equal to the spot price plus associated carrying costs such as storage costs, interest rates, etc.

How are futures prices different from forward prices?

It can be shown that if interest rates are constant (or if they change in a perfectly predictable way), the theoretical no-arbitrage forward and futures prices are the same. However, in practice, interest rates do vary unpredictably, and futures prices are therefore different from forward prices.

What should be the price of a forward contract?

For profits to be realized, the forward price should, therefore, be greater than USD 47.35185. The trader sells the asset and enters into a forward contract to buy it back at USD 40.

How is the price of a futures contract determined?

Pricing Futures  Pricing of futures contract is very simple. Using the cost-of-carry logic, we calculate the fair value of a futures contract.  Every time the observed price deviates from the fair value, arbitragers would enter into trades to capture the arbitrage profit.  This in turn would push the futures price back to its fair value. 32.

How to find the spot price of futures?

F = (S− I)(1+R)T F = ( S − I) ( 1 + R) T The spot price, S can be found by making S the subject of the formula; S = I+ F (1+R)T S = I + F ( 1 + R) T If F > (S − I) (1 + R) T, to realize profits, traders should buy the assets and sell them in the forward markets.

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