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CMA Final · Strategic Financial Management

Forwards and Futures for CMA Final SFM

Forwards and futures are contracts to buy or sell an asset at a fixed price on a future date. A forward is private and customised; a future is exchange-traded and marked to market daily. To solve questions, find the cost-of-carry fair price, compare it with the market price, then hedge, speculate or arbitrage.

What this chapter covers

This chapter covers derivative contracts that fix a price today for a trade on a future date. You learn how a forward is priced, how a futures contract works on an exchange, and why the two differ in credit risk, margining and settlement.

The numerical core is the cost-of-carry idea. The fair futures price is the spot price plus the cost of holding the asset until expiry, less any income it gives. For stock and index futures you adjust for interest and dividends. From there you move to uses: hedging with a hedge ratio, speculation, and arbitrage when the market price differs from the fair price. The chapter ends with interest rate and currency futures.

The chapter links to other parts of Paper 14. Currency futures connect to foreign exchange risk management. Index and stock futures connect to portfolio management, where you change a portfolio's beta using futures. Options come next in the paper and build on the same payoff thinking, so a firm base here makes that chapter easier.

Derivatives are a regular source of questions in Paper 14, in both the 2-mark MCQs and the 14-mark numerical questions. The calculations are short and rule-based, so you can score well once the method is clear. A question often asks for a fair price, a decision to hedge, and the result of the hedge in one working. Marks go to a clear recommendation, so practise this chapter until the steps are automatic.

Forwards and Futures: topics in the order to study them

  1. 1Forward Contracts: Features and PricingStart here because it introduces the cost-of-carry logic in its simplest form, with no margins or daily settlement.
  2. 2Futures Contracts: Features and MechanicsNext, learn how an exchange standardises the contract, with margins, marking to market and settlement.
  3. 3Difference Between Forwards and FuturesOnce you know both, compare them. This is a frequent MCQ and short-note area and fixes the ideas in memory.
  4. 4Pricing of Stock and Index FuturesApply cost of carry to shares and indices, adding dividends and continuous or simple interest as the question requires.
  5. 5Hedging with Futures and Hedge RatioFair price comes first because you need it to judge a hedge. Then learn how many contracts to take and the outcome.
  6. 6Speculation and Arbitrage Using FuturesArbitrage compares market price with fair price, so it needs the pricing topics. Speculation needs margin and payoff mechanics.
  7. 7Interest Rate and Currency FuturesStudy these last. They reuse the same logic with interest rate differentials and exchange rates, and link to forex management.

How to prepare Forwards and Futures

This chapter rewards method over memory. Build each calculation from one idea and practise it in the exam format.

  1. Read the contract basics first: underlying, lot size, expiry, margin and settlement. Write them as a short list in your own words.
  2. Learn the cost-of-carry formula and rebuild it from first principles: spot price, plus financing cost, less income. Do not memorise it as an isolated formula.
  3. Solve three or four pricing problems for each asset type. Check whether the question gives simple or continuous interest, and whether dividends come before expiry.
  4. Practise marking to market with a daily price table. Track margin balance day by day and note when a margin call arises.
  5. Work hedge ratio questions fully: find the number of contracts, round sensibly, then show the hedged and unhedged results side by side.
  6. For arbitrage, always compute fair price first, state whether the future is overpriced or underpriced, then list the buy and sell legs and the profit.
  7. Finish with timed mixed questions and a few MCQs on forward versus futures differences. Write the recommendation line in every answer.

Common mistakes in Forwards and Futures

  • Using the wrong time period in the pricing formula

    Fix: Write t as a fraction of a year before you start, such as 3 ÷ 12, and check it against the interest rate basis given.

  • Ignoring dividends or counting them at the wrong point

    Fix: Scan the question for dividends and their dates. Include only those received before the contract expires.

  • Taking the wrong side in an arbitrage

    Fix: Compute fair price first. Overpriced future means sell the future and buy spot; underpriced means the reverse.

  • Getting hedge results wrong by mixing long and short positions

    Fix: State the exposure first, such as a holder of shares who fears a fall, then pick the position. Show gain or loss on each leg.

  • Forgetting lot size and margin in the final working

    Fix: Multiply by lot size and number of contracts, and include margin where the question asks for return on margin.

  • Writing vague differences between forwards and futures

    Fix: Learn a fixed set of points: trading venue, standardisation, counterparty risk, margin, settlement and liquidity.

Last-day revision: Forwards and Futures

  • A forward is an over-the-counter, customised contract; a future is an exchange-traded, standardised contract.
  • Futures are marked to market daily; forwards are normally settled only at maturity.
  • Fair futures price = spot price + cost of carry, where cost of carry is financing cost less income from the asset.
  • With simple interest: F = S × (1 + r × t), where t is in years.
  • For a share paying a dividend before expiry, deduct the dividend (or its value) from the carry.
  • If market futures price is above fair price, sell the future and buy the asset; if below, buy the future and sell the asset.
  • Initial margin is paid at entry; maintenance margin triggers a margin call when the balance falls below it.
  • Number of contracts for a hedge = hedge ratio × value of exposure ÷ value of one futures contract.
  • To hedge a portfolio with an index future, scale by the portfolio's beta.
  • A long hedge protects against a price rise; a short hedge protects against a price fall.
  • Basis = spot price − futures price, and it narrows towards zero at expiry.
  • Always end a numerical answer with a clear decision and the net result.

Forwards and Futures practice questions

Forwards and Futures in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Forwards and Futures: frequently asked questions

Is Forwards and Futures important for CMA Final Paper 14?

Yes. Derivatives are a regular part of Paper 14, and this chapter feeds into options and forex management. It can appear in both the MCQ section and the numerical questions.

What is the most important formula in this chapter?

The cost-of-carry price: fair futures price equals spot price plus the cost of carry. Most pricing, arbitrage and hedging questions depend on it, so understand how to adjust it for interest and dividends.

How do I decide whether to buy or sell a future in arbitrage?

Compare the market futures price with the fair price. If the market price is higher, sell the future and buy the asset. If it is lower, buy the future and sell the asset.

How should I practise this chapter if I study on my phone?

Use your phone for concepts, definitions and the forward versus futures comparison. Do the numerical workings on paper, since the exam is written and you need to practise layout and the final recommendation.