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FRM Part I · FRM Exam Part I · Pricing Financial Forwards and Futures

Which statement best describes why the forward price of a non-dividend-paying stock does not depend on the market's expected future spot price?

The forward price is determined by arbitrage: buying the stock today and borrowing at the risk-free rate replicates the forward, so the price depends only on spot, interest rate and time, not on expected future spot prices.

  1. AInvestors are risk-neutral so expectations cancel out
  2. BA replicating strategy of buying the stock and borrowing locks in the forward price using only the spot price, rate and timeCorrect
  3. CForward prices are set by exchange rules rather than by arbitrage
  4. DExpected spot prices are always equal to the forward price in practice

Explanation

Buying the asset now and financing it at the risk-free rate replicates the forward payoff, so arbitrage forces F0 = S0 e^(rT). Expectations of the future spot price play no role. Risk-neutrality is not required, exchange rules do not set the price, and the forward need not equal the expected spot.

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