Monetary and Nonmonetary Benefits Affecting the Value and Price of a Forward Contract
The value and price of forward contracts are affected by the benefits and costs of holding its underlying asset. Carrying costs and opportunity costs can affect the value of holding the asset, and it is sometimes beneficial to hold the…
Concepts of Arbitrage, Replication and Risk Neutrality
The concepts of arbitrage, replication, and risk neutrality are important to comprehend when pricing derivatives. We can use assumptions about arbitrage and investor risk preferences to determine derivative pricing. Arbitrage Arbitrage refers to exploiting a price imbalance in the same…
Value and Price of a Forward Contract at Expiration, During the Life of the Contract, and at Initiation
This learning outcome covers how to differentiate forward price and forward value and how these are affected differently during the initiation, life cycle, and expiration of the contract. It is crucial to understand the difference between forward price and forward…
Why Forward and Futures Prices Differ
Forward and futures contracts share several similar features; however, how they are traded and the resulting cash flows mean forward, and futures contracts with the same underlying asset may trade at a different price. Exchange-traded vs. OTC One of the…
Swap Contracts
Since a swap involves a series of payments over a fixed period of time, it can be viewed as a series of forward contracts expiring at various times over the life of the swap contract. Series of Forward Contracts The…
Value and Price of Swaps
A swap is an agreement between two parties to exchange a series of cash flows, which can also be viewed as a series of forward contracts. Swap pricing is the determination of the initial terms of the swap at the…
European Options
European options only allow for the exercise of options at the expiry date, while American options allow for early exercise. The terms do not convey any information about where, geographically, the options are traded. The right to exercise is a…
The Value of an Option
Aside from the moneyness, time to expiration, and exercise price, other factors determine the value of an option. The risk-free rate, volatility of the underlying and cash flows from the underlying and cost-of-carry impact option values. Time expiration With American-style…
Put-Call Parity for European Options
Although parity means equivalence, puts and calls are not equivalent. However, there is a relationship between the price of a call and its corresponding put option. This is referred to as put-call parity. Protective Puts and Fiduciary Calls First, let’s consider…
