CMFAS RES 2B OTC Derivatives: Products & Mechanics question: forward price for a non-dividend-paying share

CMFAS RES 2BOTC Derivatives: Products & Mechanics

A forward price for a non-dividend-paying share is generally ABOVE the spot price because:

A It reflects spot plus the cost of carrying the asset to delivery, less income
B Exchanges add a fee to forward prices to cover clearing and settlement
C The market expects the share price to rise by the delivery date
D Forwards carry more risk than spot trades, so buyers pay a risk premium

Show the answer and explanation

Answer: A. It reflects spot plus the cost of carrying the asset to delivery, less income

By no-arbitrage, F = S × (1 + r)^t for a non-income asset: a dealer can hedge a short forward by buying spot with borrowed money, so the forward must compensate the financing cost. Income (dividends, foreign interest) reduces the forward premium. Expectations are not the driver.

Common mistake

Cost of carry, not market forecasts, sets the forward price.

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