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NISM Certifications · NISM-Series-X-A: Investment Adviser (Level 1) · Understanding Derivatives

A client asks the adviser why the futures price of a non-dividend-paying stock is usually higher than its spot price. Under the cost of carry model, what is the main reason?

Under the cost of carry model, the futures price equals the spot price plus the cost of carrying the position until expiry, mainly interest on funds. With no dividends to offset it, futures trade above spot. There is no clearing corporation premium or fixed exchange add-on.

  1. AThe futures price reflects the spot price plus the cost of financing the position until expiryCorrect
  2. BFutures buyers must always pay a premium to the clearing corporation
  3. CThe spot price falls automatically before expiry
  4. DExchanges add a fixed Rs 10 to every futures contract

Explanation

In the cost of carry model, futures price = spot price x (1 + cost of carry) for the period, where the carry is mainly the interest cost of funding. Dividends would reduce the carry, but none are paid here. The other options describe things that do not exist in the pricing model.

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