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CFA Level I · CFA Level I Exam · Pricing and Valuation of Futures Contracts

Which statement best describes the law of one price, the basis of no-arbitrage pricing of futures contracts?

The law of one price states that two assets or portfolios producing identical future cash flows must sell at the same price. If they do not, arbitrageurs buy the cheaper one and sell the dearer one for riskless profit, which forces prices together. This drives futures pricing.

  1. ATwo assets with identical future cash flows must trade at the same price.Correct
  2. BA futures price must always equal the expected future spot price.
  3. CFutures prices must always exceed the current spot price.

Explanation

The law of one price says that assets or portfolios with identical payoffs in all states must have the same price, otherwise arbitrageurs buy the cheaper and sell the dearer. Futures prices are not required to equal expected spot prices, and they can lie below spot when benefits of holding the asset exceed carrying costs.

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