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By A.Chisholm.

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Suppose that forward prices in the market have a systematic tendency to underestimate the actual spot prices on future dates. Then a trader who consistently bought forward contracts would tend to make money on deals more often than he or she lost money. In some ways this seems unlikely although, following arguments proposed by the economist John Maynard Keynes, it has been suggested that this phenomenon actually does exist and the ensuing profits serve to attract Equity and Currency Forwards 15 speculators into the market.

Delivery can take place on any business day in the delivery month, at the choice of the short. The prices for future delivery are quoted per $100 par or face value in dollars and thirty-seconds of a dollar, to the nearest half of a thirty-second. 5. 375 on the actual contract size of $100 000 The tick size (one sixty-fourth of a point) is the minimum move allowed in the price quotation. 625 on the full contract value of $100 000. 625. In practice what happens is that (1) long and short positions are marked-to-market at the end of each trading day based on the closing price of the contract on the exchange, and (2) profits and losses from that day’s trading are added to or subtracted from a trader’s margin account.

5. 4926 then the arbitrage profit disappears (give or take some rounding in the figures). This simple example demonstrates why forward FX deals are transacted at or around the theoretical fair value. If they are not, then traders will quickly rush in to create arbitrage deals, and the actual market rate will move back towards its theoretical or equilibrium value. In practice, dealing spreads and transaction costs complicate the story a little but the general principle still holds. 5. Market practitioners would say that the pound is at a discount relative to the dollar for delivery in two months.

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Derivatives Demystified by A.Chisholm.

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