Pricing and Valuation · Forwards Trading Guide

A forward price can be understood by comparing a future purchase with buying and carrying the asset today. The assumptions determine whether that comparison is usable.

Construct the alternative

Imagine buying an asset now, financing it until maturity and delivering it against a future sale. In an ideal market, a forward price must be consistent with that replicating route. Otherwise buying through one route and selling through the other could create a price discrepancy. Real trades add borrowing spreads, custody, taxes, transaction costs and limits on access.

Price a simple asset

Assume a tradable asset costs $100, pays no income and has no storage costs. Financing is available at a simple annual rate of 4% for half a year. Buying and carrying one unit costs $102 at maturity. Under these assumptions the theoretical forward price is $102. This is a model result, not a forecast of the future spot price or an offer from a dealer.

Add costs and subtract benefits

For a known cash income received before maturity, subtract its present value from spot before carrying the remaining amount forward. Known storage charges can be included according to when they are paid. Physical inventory may also provide operational benefits that cannot be bought and sold as easily as the commodity itself. This convenience benefit helps explain why a mechanical financing calculation may not describe an executable commodity trade.

Test the replication before using it

Can the asset actually be borrowed, stored and delivered in the required quality? Are funding rates available for the full maturity? Is short selling feasible and are proceeds usable? If not, a theoretical difference is not automatically arbitrage. Keep a model price, an indicative market quote and an executable quote in distinct fields. Compare assumptions before interpreting the gap.

Try it yourself

An asset costs $200 with no income or storage. Simple financing is 6% annually for three months. What is the illustrative forward price?

Show the worked answer

$203, calculated as $200 × (1 + 0.06 × 0.25). The result assumes the specified funding and frictionless replication.

Further reading

Educational material. Numerical examples are hypothetical and exclude costs unless stated. Forward contracts create binding obligations and may require collateral or credit approval. Actual terms, access and risks depend on the agreement and jurisdiction.

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