CFA Level I · CFA Level I Exam · Arbitrage, Replication, and the Cost of Carry in Pricing Derivatives
A forward contract on an asset that pays no income and has no storage costs is initiated at a price that prevents arbitrage. At initiation, the value of the forward contract to either party is most likely:
The value of a forward contract at initiation is zero. The forward price is set so that neither counterparty gains an arbitrage profit, so no cash changes hands at the start, apart from any margin or collateral.
- Aequal to the spot price of the underlying
- Bequal to zeroCorrect
- Cequal to the present value of the forward price
Explanation
Forward contracts are priced so that neither party pays anything at initiation. The forward price is set at the level that makes the contract value zero. The spot price and the present value of the forward price describe other quantities, not the contract's initial value.
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