Session 16 - Derivaties - Forwards & Futures

Question 1

Forward Price

Answer 1

price that would not permit profitable risk-less arbitrage in frictionless markets.

= (Spot price at inception) x (1 +Rf)^contract term in years

Question 2

London Interbank Offered Rate (LIBOR)

Answer 2

The lending rate on dollar-denominated loans between banks. In contrast to T-bill discount rates, LIBOR is an add-on rate, like a yield on a short-term certificate of deposit. LIBOR is used as a reference rate for floating rate U.S. dollar-denominated loans worldwide.

Question 3

Currency Forward Contract

Answer 3

(Spot price) x [(1+domestic interest rate)^time / (1+foreign interest rate)^time]

Question 4

Key differences between forward and future contracts

Answer 4

• Futures are marked to market at the end of every trading day. Forward contracts are not marked to market.
• Forwards are private contracts and do not trade on organized exchanges. Futures contracts trade on organized exchanges.

Question 5

Future Price

Answer 5

(Spot price at inception) x (1 +Rf)^contract term in years

Question 6

Cash-and-carry arbitrage

Answer 6

consists of buying the asset, storing/holding the asset, and selling the asset at the futures price when the contract expires.

Question 7

Reverse cash-and-carry arbitrage

Answer 7

consists of going long in the futures contract, shorting gold, and investing the short-sale proceeds.

Question 8

Backwardation

Answer 8

a situation where the futures price is below the spot price. For this to occur, there must be significant benefit to holding the asset, either monetary or non-monetary. It might occur if there are benefits to holding the asset that offset the opportunity cost of holding the asset (the risk-free rate) and additional net holding costs

Question 9

Contango

Answer 9

Situation where the futures price is above the spot price.

Question 10

Forward Contract: Value of Long Position

Answer 10

= Spot Price - [(future price)/(1+RF)^time in years]

Question 11

Forward Contract: Value of Short Position

Answer 11

= inverse of long position

Question 12

Price of an equity forward contract w/ discrete dividends

Answer 12

remove the PV of dividends from the spot price or the FV of dividends from the forward price. Otherwise, use the standard forward formula.

Question 13

Price of an equity index forward contract with continuous dividends

Answer 13

Spot x e^(risk free rate - dividend yield)(time in years)

Question 14

Value of long position in equity index forward contract with continuous dividends

Answer 14

= [(Spot)/(e^dividend yieldtime)] - [(FP)/e^risk free ratetime)]

Question 15

Notions for Forward Rate Agreements

Answer 15

• # of months until the contract expires (e.g. 2)
• # of months until the underlying loan is settled (e.g. 3)

“2 x 3”