• Skip to primary navigation
  • Skip to main content
  • Skip to primary sidebar
  • Skip to footer
Finance Train

Finance Train

High Quality tutorials for finance, risk, data science

  • Home
  • Data Science
  • CFA® Exam
  • PRM Exam
  • Tutorials
  • Careers
  • Products
  • Login

Futures Prices vs. Forward Prices

CFA® Exam, CFA® Exam Level 2, Derivatives

This lesson is part 10 of 15 in the course Derivatives Part 1

While a futures contract is priced in the same general manner as a forward contract, there are some small differences between futures and forwards.

  • Because the daily gain/loss is settled daily on outstanding futures contracts via margin account transfers credit risk is eliminated.  Alternatively, forward contracts can accumulate significant credit risk, as the value of the forward contract will change with changes to the price of the underlying asset.
  • The margin accounts for futures contracts are invested in short term interest securities.  This difference from forward contracts adds an element to the returns from futures contracts, affecting the pricing relationship.
  • The pricing of futures contracts is affected by the correlation between interest rates and futures prices.
  • When there is positive correlation the futures contract buyer benefits as he/she is gaining more from the margin account interest and the contract price is rising.

Holding the Underlying Asset

Futures prices are based on the same arbitrage relationship applied when pricing forward contracts – the price of the future should equal the cost of buying the underlying asset at the spot price with borrowed funds.

When this relationship is not reflected in a futures contract price, an opportunity for arbitrage exists for traders and in an efficient market, the mispricing will on exist for a very short period of time.

Benefits of holding the underlying asset, as opposed to holding the futures contract:

  • Storage and carrying costs: The futures contract does not give the contract holder physical ownership; therefore the contract holder avoids storage and carrying costs. This fact increases the price of the futures contract.
  • Cash flows on the underlying: Physical ownership gives entitles the asset owner to the asset’s cash flows (such as dividends, interest coupons, etc.); the contract holder does not receive these cash flows. This fact reduces the price of the futures contract.
  • Convenience yield: Physical ownership of the underlying gives the asset owner the benefit of actually being able to consume the asset; alternatively, the holder of a futures contract cannot immediately consume the underlying. This fact reduces the price of the futures contract.
  • Daily margin cash flows: Technically there should be futures price adjustments based on the margin cash flows and interest, but this is not expected to be on the exam.
Theoretical Futures Price = Future Value of the Spot Price + Future Value of Storage Costs – Future Value of Asset Cash Flows – Future Value of Asset’s Convenience Yield
Previous Lesson

‹ Futures: Convergence of Spot and Futures Prices at Expiration

Next Lesson

Contago and Backwardation ›

Join Our Facebook Group - Finance, Risk and Data Science

Posts You May Like

How to Improve your Financial Health

CFA® Exam Overview and Guidelines (Updated for 2021)

Changing Themes (Look and Feel) in ggplot2 in R

Coordinates in ggplot2 in R

Facets for ggplot2 Charts in R (Faceting Layer)

Reader Interactions

Leave a Reply Cancel reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.

Primary Sidebar

In this Course

  • CFA Level 2: Derivatives Part 1 – Introduction
  • What are Forward Contracts?
  • Equity Forward Contracts
  • Fixed Income Forward Contracts
  • Currency Forward Contracts
  • Forward Rate Agreements (FRA)
  • Credit Risk and Forward Contracts
  • Introduction to Futures Contracts
  • Futures: Convergence of Spot and Futures Prices at Expiration
  • Futures Prices vs. Forward Prices
  • Contago and Backwardation
  • Pricing Stock Index Futures
  • Pricing Interest Rate/Treasury Bond Futures
  • Pricing Currency Futures
  • Eurodollar Futures

Latest Tutorials

    • Data Visualization with R
    • Derivatives with R
    • Machine Learning in Finance Using Python
    • Credit Risk Modelling in R
    • Quantitative Trading Strategies in R
    • Financial Time Series Analysis in R
    • VaR Mapping
    • Option Valuation
    • Financial Reporting Standards
    • Fraud
Facebook Group

Membership

Unlock full access to Finance Train and see the entire library of member-only content and resources.

Subscribe

Footer

Recent Posts

  • How to Improve your Financial Health
  • CFA® Exam Overview and Guidelines (Updated for 2021)
  • Changing Themes (Look and Feel) in ggplot2 in R
  • Coordinates in ggplot2 in R
  • Facets for ggplot2 Charts in R (Faceting Layer)

Products

  • Level I Authority for CFA® Exam
  • CFA Level I Practice Questions
  • CFA Level I Mock Exam
  • Level II Question Bank for CFA® Exam
  • PRM Exam 1 Practice Question Bank
  • All Products

Quick Links

  • Privacy Policy
  • Contact Us

CFA Institute does not endorse, promote or warrant the accuracy or quality of Finance Train. CFA® and Chartered Financial Analyst® are registered trademarks owned by CFA Institute.

Copyright © 2021 Finance Train. All rights reserved.

  • About Us
  • Privacy Policy
  • Contact Us