Forward/Future Price vs Forward/Future Value

[panasonic_chai]

Hi David,

This question must have been asked many times but im still very confused by the notation used here.
Is there any difference between price and value of a forward/future contract?

Thanks

 

[David Harper CFA FRM]

Hi panasonic,

It's a good question b/c it creates confusion (and, IMO, a great example of why attention to the basics makes subsequent study easier and ignoring same makes study harder). We follow Hull, where value is denoted small (f):

f = (F0 - K)*exp(-rT)
note: this is same as S0 - K*exp(-rT) b/c F0 = S0*exp(rT)

So:

1. when futures/forward contracted is entered, forward price (F0) = delivery price (K) and value = 0
e.g., enter long gold futures contract today (T0) where F0 = $1,100; K = $1,100 and value (f) = 0

2. now fast forward in time (next month?) to T1:
* the delivery price on our contract is unchanged/constant; e.g,. K = $1,100
* the forward price at T1 will be different; e.g., F1 = ?
* the value (f) will likely be non-zero: in f = (F0 - K)*exp(-rT), K is same but F0 has changed

From Hull: "It is important to be clear about the meaning of the variables F0, K, and f . At the beginning of the life of the forward contract, the delivery price, K, is set equal to the forward price, F0, and the value of the contract, f, is 0. As time passes, K stays the same (because it is part of the definition of the contract), but the forward price changes and the value of the contract becomes either positive or negative. A general result, applicable to all long forward contracts (both those on investment assets and those on consumption assets), is f = (F0 - K)e-rT"

Hope that helps, it's a *good question* - David