Estimation of Forward Prices / Futures using Cost of C

Investment assets vs. consumption assets

An investment asset is an asset that is held mainly for
stocks, bonds, gold, and silver
A consumption asset is an asset that is held primarily
example, oil, meat, and corn

Short selling
Selling or shorting that you do not own and buying ba
Selling an asset that is not owned - cash flows from sh
shares back. Mostly used, when the market is bearish

Forward Price = Spot Price + Cost of Carry

Forward prices and futures prices

Under the assumption that the risk-free interest rate
maturities, the forward price for a contract with a cer
futures price for a contract with the same delivery da
Futures price = delivery price determined as if the con
The formulas for forward prices apply to futures price
Stock index futures
Stock index futures: futures contracts written on stoc
Futures contracts can be written on many indices, suc
DJIA: price weighted, $10 time the index
Nikkei: price weighted, $5 times the index
S&P 500 index: value weighted, $250 times the index
NASDAQ 100 index: value weighted, $20 times the in
Nifty50: 50 times the index value

Currency futures
Exchange rate and exchange rate risk
Direct quotes vs. indirect quotes
1 GBP=$1.60
GBP/USD 1.60
General formula: F0 = S0 * (rh-rf)T, where rf is the fo
Note On Convinience Yield Calculation
Convinience Yield Formula
Y=(interest cost + Storage Cost) - (1/time * ln(Futures

Forward /Futures(Acutal)>Forward/ Futures(Theoritic

Cash and Carry Arbitrage
On Day 0

Borrow So

Buy Underlying

Sell Forward

Value of a Forward Contract

The value, f, of a long forward contract is
The Value f, of a Short forward

SPOT PRICE
FORWARD PRICE OR FUTURES PRICE
 ESTIMATE THE PRICE USING COST OF CARRY MODEL
WE COMPARE THE FUTURES PRICE WITH THEORITICA

MARKET FUTURES PRICE > THEORITICAL PRICE

MARKET FUTURES PRICE < THEORITICAL PRICE

WHEN THE FUTURES PRICE IS OVER PRICED

THE ARBITRAGE PROCESS
SELL THE FUTURES, BUY THE STOCK
TIME TOBORROW @ RFR FOR TILL EXPIRY OF FUTURES
TIME T SELL THE STOCK

WHEN THE FUTURES PRICE IS UNDER PRICED

BUY THE FUTURES, SELL THE STOCK
SELL THE STOCK, INVEST THE POSITIVE CASH FLOW A
BUY THE STOCK AT EXPIRY AT FUTURES PRICE (CONTR
ARBITRAGE= AMOUNT REALIZED FROM THE INVESTM
orward Prices / Futures using Cost of Carry Model

ets vs. consumption assets

asset is an asset that is held mainly for investment purpose, for example,
old, and silver
asset is an asset that is held primarily for consumption purpose, for
eat, and corn

ng that you do not own and buying back latter.

that is not owned - cash flows from short sale and purchase of
ostly used, when the market is bearish.

Spot Price + Cost of Carry

and futures prices

mption that the risk-free interest rate is constant and the same for all
forward price for a contract with a certain delivery date is the same as the
r a contract with the same delivery date.
delivery price determined as if the contract were negotiated today
r forward prices apply to futures prices after daily settlement
ures: futures contracts written on stock indexes
ts can be written on many indices, such as
hted, $10 time the index
eighted, $5 times the index
value weighted, $250 times the index
dex: value weighted, $20 times the index
es the index value

nd exchange rate risk

s. indirect quotes Direct Quote in US

a: F0 = S0 * (rh-rf)T, where rf is the foreign risk-free rate

rh is the home currency risk free int
ience Yield Calculation
ld Formula
+ Storage Cost) - (1/time * ln(Futures Price/ Spot Price))

es(Acutal)>Forward/ Futures(Theoritical)
Arbitrage
On Maturity Date T On Day 0
Short Sell Underlying
Deliver the Underlying asset at S0
Lend S0 for a period
Receive F(acutal) equal to maturity

Return S0 with interest Buy Forward

ard Contract
a long forward contract is Spot Price - PV of Contract Price or Forw
a Short forward

S0
E OR FUTURES PRICE
PRICE USING COST OF CARRY MODEL THEORITICAL PRICE
THE FUTURES PRICE WITH THEORITICAL PRICE

ES PRICE > THEORITICAL PRICE FURTURES PRICE IS OVER PRICED

ES PRICE < THEORITICAL PRICE FURTURES PRICE IS UNDER PRICED

URES PRICE IS OVER PRICED

E PROCESS
RES, BUY THE STOCK
R FOR TILL EXPIRY OF FUTURES
ARBITRAGE =FUTURES CONTRACT PRICE YOU RECEIVE- BORROWED M

URES PRICE IS UNDER PRICED

RES, SELL THE STOCK
K, INVEST THE POSITIVE CASH FLOW AT RFR TILL EXPIRY
AT EXPIRY AT FUTURES PRICE (CONTRACT PRICE)
MOUNT REALIZED FROM THE INVESTMENT - BOUGHT THE STOCK AT EXPIRY
for example,

ose, for

me for all
e same as the

today
ency risk free int rate
 Reverse Cash and Carry Arbitrage
On Maturity Date T

Receive S0 and interest

Take Delivery of the
underlying and Pay Fo
Deliver the underlying to
make up for the short sale

act Price or Forward Price

R PRICED
ER PRICED

E- BORROWED MONEY + INT

TOCK AT EXPIRY
Int Rates Conversion

Given
Stated Int Rates
Discret ==>
Equivalent
5.00%
Annual Discrete Int ==> Continous Compounding

8.162%
Semi Annual Compounding

Given
Stated Int Rates
Continous
Compounding
==> Discreet Int rates
8%Equivalent

8.00%

Note : Very careful here : no of times compounding x (exp(Rc

Rc Cotinously Compounding int rates
Rm Discreet compounding with m times

Note : Do not confuse with equivalent int rates with effective

What Is an Effective Annual Interest Rate?

An effective annual interest rate is the real return on a saving
any interest-paying investment when the effects of compoun
It also reflects the real percentage rate owed in interest on a

Effective Interest Rates

Given Int reates ==>

8%*
Not equivalent
Different Compounding frequencies

Calculating Effective Interest Rates

The effective interest rate is calculated through a simple
In this formula, r represents the effective interest rate,
i represents the stated interest rate, and n represents the nu

If interest is compounded continuously, you should calcu

: r = e^i - 1. In this formula, r is the effective interest rate, i is t

Effective Rates

Effective Rates ==> ==>

8%
 Equivalent Rates

Continous Compounding

4.879%
s Compounding

8.000%

Int rates
8.32871%
Annual Compounding Discreet
8.16215%
Semi annual Discreet

mes compounding x (exp(Rc/m)-1)

ompounding int rates
pounding with m times

alent int rates with effective interest rates

Rate?
s the real return on a savings account or
when the effects of compounding over time are taken into account.
e rate owed in interest on a loan, a credit card, or any other debt.

Effective Rates
Semi Annual Quarterly Weekly Daily
8.16% 8.243% 8.32% 8.3278%

alculated through a simple formula: r = (1 + i/n)^n - 1

e effective interest rate,
ate, and n represents the number of compounding periods per year.

nuously, you should calculate the effective interest rate using a differe
e effective interest rate, i is the stated interest rate, and e is the constant 2.7

Nominal Interest Rates

Semi Annual Quarterly Weekly Daily

7.85% 7.771% 7.70% 7.6969%
account.
er debt.

Continous Compounding
8.3287067674958600%
ds per year.

ate using a different formula

e is the constant 2.718
Contango

Observed Forward /Futures Price > the Spot Prices

Backwardation Inverted Curve Observed Forward /

> the Spot Prices
Features of Contango

Risk free rate of int > Lease rate > Yield Rate

Most of the financial contracts, will have con

Forward prices Vs Expected Spot prices will d

contango or Backwardation

bserved Forward / Futures Prices < Spot Price

Note Features of Backwardation

Risk free is less than Convinience Yield or Lea

Also the lesser the storage value, backwardati
Oil storage is expensive, the backwardation w
For a long position, it is profitable, as the forw
For a short position, it is not profitable

Backwardation can be seen mostly in Commo

Example of Basis risk
Current Spot Price : 1
6 month Futures
The basis
e rate > Yield Rate

racts, will have contango

ed Spot prices will determine the

dation

inience Yield or Lease Rate

e value, backwardation will be rare. (eg. Gold)
he backwardation will occur.
ofitable, as the forward price is < the spot price
ot profitable

n mostly in Commodity futures

xample of Basis risk
urrent Spot Price : 1500
month Futures 1550
he basis 50
 Estimation of Forward /Futures Price using Cost of Carry Mod

1Basic cost of carry without any known income or storage

2Forward price using fixed storage cost
3Forward price using proportionate storage cost
4Forward price using fixed income
5Forward price using proportionate income or yield
6Forward price using convinience yield
7Forward price of a currency
g Cost of Carry Model

ome or storage

or yield
Basic Model
Current Market Price of a stock is Rs
Risk free rate of interet is
Period
Calculate the 87 day forward price of the stock
Spot price * exp(r*t)
 500
4% CC
87days
e stock
504.789921147983

504.789921147983
0.24
d/365 n/12

504.790
Estimation of forward price using fixed st

Current price of Oil per bbl 75

Storage cost per bbl
to be paid at the beginning of each mont
Risk free rate of int 4%
Tenor 6months
Calculate the 6 month forward price of 1

Given
CMP of oil per bbl 75
1000 bbls of oil at current price
Storage cost to be paid
begiining of. every mont 3
RFR
Time
Storage cost is given
Step1 calculate the present value of stora

Term PV of storage
0 3000 3000
1 3000 2882.36832
2 3000 2769.34904
3 3000 2660.76131
4 3000 2556.43137
5 3000 2456.19226
16,325.10

Step 2
Calculate the 6 month forward price usin
93,169.99
 ng fixed storage

each month 3
CC
months
price of 1000 bbls of oil

75000

3000
4%cc
0.5
ue of storage

price using storage cost

Given
CMP
RFR
Time
4 quarters
Storage cos
Quantity
Storage cos

Step 1 calcu
Term
0
0.25
0.50
0.75

Step2
Forward Pri
Forward pric
Given
32
3%cc
1Year
quarters
torage cos 1.5Beginning of each month
Quantity 5000
torage cos 7500

tep 1 calculate the PV of strorage cost

PV of Storage
7500 7500
75007443.9604111
7500 7388.339547
7500 7333.134279
29,665.43
tep2
orward Pri 195,441.61
orward price of one bbl 39.09
ach month
Current Price of Turmeric in the commodity market is
The risk free rate of int is
Storage cost is
Calcualte 5 month forward price of turmeric

Given
Spot price
RFR
Storage cost
Time
5 month forward price
market is

780
4.50%CC
3%CC
0.416666666666667
804.7598578493
 780per kg
4.50% CC
3% CC
 A bond is issued with a coupon of 6% paid semi annually
Bond matures in 2 years.
Calculate the forward price of the bond with the face value of
with rfr of 4%CC
Assume current spot price of the bond Market price
Given
Time 2years
Bond Face value 1000
RFR 4%
Coupn rate 6%Semi annual
Calcualte 2 year Forward price

Step 1 Caclulate the present value of the coupons payable

Term Coupon PV of Coupon

0.5 30 29.4059602
1 30 28.82368317
1.5 30 28.25293601
2 30 27.69349039
PV of coupon amounts 114.176
Bond Features

Face value and redemption value

Coupon rate
RFR
Calculate the 2 yeare forward price

Current price of the bond

PV OF INCOME

FORWARD PRICE OF THE BOND

Current Price CF PV of CFS
0.5 30 29.4059602
1 30 28.82368317
1.5 30 28.25293601
2 30 27.69349039
114.18
mi annually

he face value of 1000 and

Market price 950

emi annual

pons payable

Forward Price 905.437

 1000
6% Semi annual
4% CC

950.00

114.18

905.43725447

COUPON IS PAID ON T
COUPON % OF FACE V

FV 1000
COUPON RATE
SEMI ANNUAL
UPON IS PAID ON THE FACE VALUE
UPON % OF FACE VALUE

6%
30
Let us current value of Nifty is 18500
Risk free rate of interest
There is a yield of 3% expected in the 3 months
Calculate the 3 months futures price using the above?

Time 0.25
RFR 4%
Spot 18500
Yield 3% cc
3 month Futures Price 18546.307860707

Colnvinience Yield example

Current spot price of $70 per bbl
An oil merchant current holds 50 mn barrels of oil
He has agreed to sell his oil at $80 per bbl in 6 months time.
There is a convinience yield of 2% on his holdings.
The risk free rate of interest is
The storage cost is
Calculate the 6 month forward price for 50 mn barrels of oil a
Given
Spot price 70
RFR 4% CC
Storage Cost 3% CC
Conv. Yield 2% cc
Time 0.5
6 months forward price
50 mn barrels

The oil merchant has agreed to sell @80.00 but the estimated
Hence oil merchant forward price is over priced and he make
Arbitrage due to his forward price
 4%

the above?

18546.3078607072

s of oil
n 6 months time.
ldings.
4%
3% CC
mn barrels of oil and comment on the agreed price of the seller, whether th
 71.77205843671Spot price *exp((r+u-y)*t)
3,588,602,921.84

but the estimated forward price is only 71.77

iced and he makes profit more than the theoritical forward price
8.2279
 3%Pa CC

seller, whether there is any arbitrage?

e *exp((r+u-y)*t)

d price
 If the int rates are given in Cont. com
Given
Spot price of USD/INR 78.05
Risk free rate of interest in India
Risk free rate of interest in US
time 0.5
Calculate the 6 month forward price of USD/INR?

Given
USD/INR 78.05=> USD is FC
==> INR is HC

Forward price of USD/ INR for 6 moths

If the int rates are given in discreet annual %

Given
Spot price of USD/INR 78.05
Risk free rate of interest in India
Risk free rate of interest in US
time 0.5
Calculate the 6 month forward price of USD/INR?

Given
USD/INR 74.5=> USD is FC
==> INR is HC

Risk free rate of interest in US

time 0.5

Forward price of USD/ INR for 6 months

GIVEN GBP/USD 1.38

INT RATE IN UK 2.75%

INT RATE IN US 0.50%

CALCULATE THE 6 MONTH FORWARD PRICE O

FORWARD PRICE OF GBP/USD

USD/GBP 0.7246
FORWARD PRICE OF USD/GBP
given in Cont. compounding

6% CC HC int rate
2.50% CC FC int Rate

ce of USD/INR?

79.4279

t annual %

HC int rate
6% per annual annual compounding FC int Rate
2.50% per annual annual compounding
ce of USD/INR?

6% per annual annual compounding 0.03

2.50% per annual annual compounding 0.0125

79.399

GBP IS FC, US IS LOCAL CURRENCY

CC
CC

H FORWARD PRICE OF GBP/USD

1.36456

USD IS FC GBP IS HC
0.73284
CURRENT DATE
EXPIRY DATE
NO OF DAYS
TIME
RFR
SPOT PRICE
FUTURES PRICE
GIVEN BY THE NSE

THEORITICAL PRICE
 10/27/2021
12/30/2021
64
0.175342465753425
5.7%
512.75
?
517.9

517.90
Risk free rate

spot price (Rs)

100.00
100.00

Given
Spot Price
Time
Storage cost
Risk Free rate
Cost of carry
Futures Price
Actual Futures Price
Implied Cost of carry

Convinience Yield

Convinience Yield
Formula : Convinience Yield C.C %= Ln(Theortical Price/Actu

Implied Cost of Carry in % Cc

or if there is no costs or income in $

Spot Price
Time
Storage cost
Risk Free rate
Cost of carry
Futures Price
Actual Futures Price
Implied Cost of carry

Convinience Yield

Convinience Yield
 5%

T ( days to Storage Expected Actual price of

cost (% price of future future contract
settlement) p.a.) contract (Rs) (Rs)

30 6.00% 100.91 100.85

25 4.00% 100.62 100.84

100
0.082191780830 days
6%CC
5%
11%
100.908209
100.85
Ln(Actual Futures price / Adjusted Spot Price)/ time
10.298%
Difference between Cost of carry -Implied Cost of Carry
0.7020%

0.0070203793
eortical Price/Actual Futures price)/time

=Ln(Actual Futures Price/ Adjsuted Spot price)/time

=Ln(Actual Futures Price/ Spot price)/time

100
0.068493150725 days
4%CC
5%
9%
100.61834225
100.84
Ln(Actual Futures price / Adjusted Spot Price)/ time
12.213%
Difference between Cost of carry -Implied Cost of Carry
-3.2128%
-3.213%Formula : Convinience Yield C.C %= Ln(Theortical Price
 Expected Implied cost of Convenienc
cost of carry e yield (%
(% p.a.) carry (% p.a.) p.a.)

11.000% 10.30% 0.70%

9.00% 12.21% -3.21%
Ln(Theortical Price/Actual Futures price)/time
Define the following terms in the context of future/forward contracts
1 Open interest Open interest is the total number of open or outstandin
2 SPAN margin Standardized portfolio analysis of risk (SPAN). This is a le
3 Exposure margin Exposure margin is themargin charged over and above
4 Marking-to-market Measure of the fair value of accounts that can change o
4 Basis Basis is the variation between the spot price of a delive
5 Spread It is the price difference or price range
6 Implied cost of carry It is the cost of carry considered for the actual price of t
7 Notional value The notional value is the total amount of a security's un
8 Contango Contango refers to a situation where the future spot pr
9 Backwardation Backwardation is a theory developed in respect to the p
10 Interpretation of convenience yield A convenience yield is an implied return on holding inve

Compare and contrast

1 Futures vs forward contracts Futures are traded on an exchange whereas forwards a
2 Selling vs shorting Selling is when you have or own or possess an asset and
3 Expected vs Implied cost of carry Expected cost of carry considers the expected rate and

Write the formulas for the following

1 Expected futures price for a stock in terms of spot price, number of days to expiry, dividend, number o
2 Implied cost of carry for an equity futures contract in terms of spot price, basis, dividend, number of d
3 Convenience yield for a commodity future contract interms of spot price, risk free interest rate, storag
4 Expected forward price for USDINR contract in terms of spot price , risk free rate in India, risk free rate
al number of open or outstanding (not closed or delivered) options and/or futures contracts that exist on a given day, delivered on a partic
analysis of risk (SPAN). This is a leading margin system, which has been adopted by most options and futures exchanges around the world
margin charged over and above the SPAN margin
ue of accounts that can change over time, such as assets and liabilities
tween the spot price of a deliverable commodity and the relative price of the futures contract for the same actual that has the shortest du
e or price range
nsidered for the actual price of the future contract
e total amount of a security's underlying asset at its spot price. 
uation where the future spot price is below the current price, and people are willing to pay more for a commodity at some point in the fut
ory developed in respect to the price of a futures contract and the contract's time to expire. As the contract approaches expiration, the fut
n implied return on holding inventories. It is an adjustment to the cost of carry in the non-arbitrage pricing  formula for forward prices in m

n exchange whereas forwards are traded over the counter. Futures are standardised contracts while forwards are not standardised.
e or own or possess an asset and decide to sell it whereas shorting is when you sell an asset without owning or possessing it in the futures
onsiders the expected rate and expected price of the future contract whereas the implied cost of carry considers the actual cost

ys to expiry, dividend, number of days to dividend, risk free rate of interest *=Adjusted Spot*EXP(RiskfreeR
ce, basis, dividend, number of days to expiry, number of days to dividend *= 365*LN(Actual price/Adjuste
ce, risk free interest rate, storage cost, actual price of futures contract, number of days to expiry
k free rate in India, risk free rate in US
 given day, delivered on a particular day.
es exchanges around the world

e actual that has the shortest duration until maturity.

modity at some point in the future than the actual expected price of the commodity.
approaches expiration, the futures contract trades at a higher price compared to when the contract was further away from expiration.
 formula for forward prices in markets with trading constraints. This makes it possible for backwardation to be observable.

rds are not standardised.

g or possessing it in the futures market.
nsiders the actual cost

*=Adjusted Spot*EXP(RiskfreeRate*n/365)
*= 365*LN(Actual price/Adjusted Spot price)/n
*=Expected Cost of Carry - Implied Cost of Carry
urther away from expiration.
o be observable.