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The difference between the futures price and the cash price is the cost of carry or the cost of ownership of the asset. For example if you compare exposure to the gold market with a futures contract as opposed to ownership of gold bullion. The futures market allows you exposure to the gold market without the costs associated with ownership of the physical gold: storage, security, financing etc. Hence you would expect the cost of a futures contract to be greater than the cash price. This difference will then diminish as the futures contract approaches expiry. At the close of the last trading day the price will be equal to, or very close to, the cash price. Arbitrageurs ensure that the futures price stays closely bound to the fair value price, which is the price at which there is no advantage in holding a position in the futures market as opposed to the underlying cash market or vice versa. Using the FTSE100 futures market as an example. Assuming the following: Ftse100 Index (Cash) stands at 5000 ( 50,000 at 10 a point) Interest Rate 4% Dividend Rate 2% Contract expires in: 3 months FTSE100 Futures = cash price + interest - dividends Fair Value = 50,000 + ((50,000 x 4%) - (50,000 x 2%)) / 4 = 50,000 + (2000-1000) / 4 = 50,000 + 250 = 50,250 So we would expect the FTSE100 to be trading at, or close to, 5025. Usually the cost of buying the shares that make up the FTSE100 index is greater than the dividend yield so the futures prices will trade at a price higher than the underlying index. Since dividends are paid unevenly throughout the year, the 14 |
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