The forward price is also known as the forward rate. It could be explained as the price that is fixed for an asset in a forward contract. The forward price may also be described as a spot price. This could be done by employing the supposition of rational pricing. This also nullifies the chances of an arbitrage.
When a forward price is written it has no worth. This is because of the special characteristics of forward price. When there is an alteration in the worth of the asset that is also a part of the future contract. The worth of the forward contract also undergoes changes. It may increase or decrease.
The new worth depends on the status of the particular asset. The prices of forward contracts are usually determined in a manner that is like the futures contracts.
Steps in Forward Pricing
The initial step in determining the price of a forward contract is just like that of a futures contract. While pricing the forward contract, at first the spot price is added to the cost of carry.
Difference between Futures Contract and Forward Contract
The process of fixing the price of a forward contract is different in some ways than a futures contract. The price of a forward contract is determined by admitting a premium. This is meant to cover for the credit risks that the counterparties may face.
Equational Representation of Forward Price
Following is the equational representation of forward price:
F = S0e(r+q)T – Σ Ni=1Dier(T-ti)
In this formula:
Di represents the dividend. It is supposed to be paid at the time ti when 0<ti
F represents the forward price. It has to be paid at a time T
q represents the cost-of-carry
ex represents the exponential function. It is employed to measure the interests that are compounding
s0 represents the spot price of the particular
r represents the rate of interest that is free of risks
Last Updated on : 1st July 2013