Question

Explain how the derivative market determined the future price of an assets

Answer 1

The future price of the asset is derived by the spot rate/price in the derivate market. This spot rate is then adjusted for time and dividend involved in the contract

A spread in the derivate market = Future Price - Spot Rate. It is also known as spot future parity.

future price of the asset gives the reason for the difference in the spot and the future market.

Future Price of an asset is calculated using the following formula:

FP = SR*(1 + rf -d)

where FP= Future Price

SR = Spot Rate

rf = risk-free rate

d = dividend

However, the risk-free rate is adjusted for the expiry time of the contract in below way:

FP = SR*(1 + rf*(x/365) -d)

where x = # of days to expiry of contract

Future Price is also known as the fair price.