FMP10 - Pricing Financial Forwards and Futures Flashcards
Define and describe financial assets
Assets whose value derives from a claim of some sort
Define short-selling and calculate the net profit of a short sale of a dividend paying stock
When short-selling, the dividend payment goes to who the investor who actually owns the stock. i.e. dividend payment must be removed from the profit
Calculate forward price given a spot price and describe an arbitrage argument between spot and forward prices
No income stock:
F = S(1 + R) ^T
- if F > S(1 + R)^T arbitrage profit of F - S(1 + R)^T by buying asset and shorting forward
Known income stock:
F = (S - I)(1 + R)^T
- F > … buy asset short forward
Known yield stock:
F = S ((1 + R) / (1 + Q))^T
S = spot price, F = future price, R = risk free rate, I = PV of income, Q = yield
Distinguish between the forward price and the value of a forward contract
At outset, forward contract has almost zero value. As time passes and the price of the asset changes, the value of the forward contract becomes positive or negative
Calculate the value of a forward contract on a financial asset that does or does not provide income or yield
No income:
Vf = S - (K / (1 + R)^T)
Known income:
Vf = S - I - (K / (1 + R)^T)
Known yield:
Vf = (S / (1 + Q)^T) - (K / (1 + R)^T)
S = spot price, F = future price, R = risk free rate, I = PV of income, Q = yield, K is forward to buy asset a price
Explain the relationship between forward and futures prices
In theory should be the same price, but in practice very different due to correlations between underlying assets and interest rates
Calculate the value of a stock index futures contract and explain the concept of index arbitrage
Value is found by known yield price of a forward
Index arbitrage is where is futures price on an index is greater than the theoretical price, trader can buy the portfolio of stocks underlying the index and short the futures and lock profit.
