Factors that Determine the Value of an Option
The factors that affect the value of an option include the value of the underlying, exercise price, time to maturity, risk-free rate, volatility, and income or cost associated with the underlying. Value of the Underlying The value of the underlying…
Arbitrage in Contingent Claims
Recall that arbitrage opportunities occur if the law of one price does not hold. The no-arbitrage conditions in options are based on the payoff at maturity. Unlike forward commitments with symmetric profiles (as presented earlier), contingent claims have asymmetric payoff…
Exercise Value, Moneyness, and Time Value of an Option
Options are derivative instruments that give the option buyer the right, but not the obligation, to buy (call option) or sell (put option) an asset from (or to) the option seller at a fixed price on or before expiration. In…
Price and Value of Swaps
Remember that a swap contract involves a series of periodic settlements with a final settlement at maturity. Swap price (or par swap rate) is a periodic fixed rate that equates the present value (PV) of all future expected floating cash…
Comparison of Swaps and Forward Contracts
Recall that a swap is a derivative contract between two counterparties to exchange a series of future cash flows. In comparison, a forward contract is also an agreement between two counterparties to exchange a single cash flow at a later…
Value and Price of Futures Contracts
Recall that during the initiation of a forward commitment, no cash changes hands. Further, the forward commitment is neither a liability nor an asset to a buyer or the seller. As such, the value of both the forward contract and…
Why Forward and Futures Prices Differ
Forward and futures contracts share 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. Causes of Differences 1. Mark-to-Market (MTM), Margining,…
Interest Rates Forward Contracts
The link between the spot and forward prices is determined by a risk-free interest rate which is regarded as the opportunity cost of holding an asset. Term structure implies that various interest rates are available depending on the time to…
Price and Value of Forward Commitments
The price of a forward commitment is agreed upon at the contract’s initiation and remains fixed until the contract’s maturity. Moreover, the price is also used in determining the basis on which the underlying will be traded in the future…
Forward vs. Spot Prices
The spot price is the price an investor must pay immediately to acquire the asset. In other words, it is the asset’s current value or the amount that sellers and buyers agree it is worth. On the other hand, the future…
