What is a 'Forward Price'

A forward price is the predetermined delivery price for an underlying commodity, currency or financial asset decided upon by the long (the buyer) and the short (the seller) to be paid at predetermined date in the future. At the inception of a forward contract, the forward price makes the value of the contract at that time, zero.

The Forward Price can be determined by the following formula:

Forward Price

BREAKING DOWN 'Forward Price'

The forward price of the contract is mainly based on the current spot price of the underlying asset. Although the contract has no intrinsic value at the inception, over time, a contract may gain or lose value. Offsetting positions in a forward contract are equivalent to a zero-sum game. For example, if one investor takes a long position in a pork belly forward agreement and another investor takes a short position in a forward agreement, any gains in the long position equals the losses that the second investor incurs from the short position. By initially setting the value of the contract's value to zero, both parties are on equal ground at the inception of the contract.

Forward Price Calculation Example

When the underlying asset in the forward contract does not pay any dividends, the forward price can be calculated using the following formula:

F = S x e^(r x t)

Where:

F = the contract's forward price

S = the underlying asset's current spot price

e = the mathematical irrational constant approximated by 2.7183

r = the risk-free rate that applies to the life of the forward contract

t = the delivery date in years

For example, assume a security is currently trading at $100 per unit. An investor wants to enter into a forward contract that expires in one year. The current annual risk-free interest rate is 6%. Using the above formula, the forward price is calculated as:

F = $100 x e ^ (0.06 x 1) = $106.18

If the underlying asset pays dividends over the life of the contract, the formula for the forward price is:

F = (S - D) x e ^ (r x t)

Here, D equals the sum of each dividend's present value, given as:

D = PV(d(1)) + PV(d(2)) + ... + PV(d(x)) = d(1) x e ^ -(r x t(1)) + d(2) x e ^ -(r x t(2)) + ... + d(x) x e ^ -(r x t(x))

Using the example above, assume that the security pays a 50-cent dividend every three months. First, the present value of each dividend is calculated as:

PV(d(1)) = $0.5 x e ^ -(0.06 x 3/12) = $0.493

PV(d(2)) = $0.5 x e ^ -(0.06 x 6/12) = $0.485

PV(d(3)) = $0.5 x e ^ -(0.06 x 9/12) = $0.478

PV(d(4)) = $0.5 x e ^ -(0.06 x 12/12) = $0.471

The sum of these is $1.927. This amount is then plugged into the dividend-adjusted forward price formula:

F = ($100 - $1.927) x e ^ (0.06 x 1) = $104.14

RELATED TERMS
  1. Forward Premium

    When dealing with foreign exchange (FX), a situation where the ...
  2. Covered Interest Arbitrage

    The practice of using favorable interest rate differentials to ...
  3. Forward Exchange Contract

    A special type of foreign currency transaction. Forward contracts ...
  4. Compounding

    The ability of an asset to generate earnings, which are then ...
  5. Long Dated Forward

    A type of forward contract commonly used in foreign currency ...
  6. Outright Forward

    A forward currency contract with a locked-in exchange rate and ...
Related Articles
  1. Trading

    The Difference Between Forwards and Futures

    Both forward and futures contracts allow investors to buy or sell an asset at a specific time and price.
  2. Trading

    Why Forward Contracts Are The Foundation Of All Derivatives

    This article expands on the complex structure of derivatives by explaining how an investor can assess interest rate parity and implement covered interest arbitrage by using a currency forward ...
  3. Investing

    What is a Forward Contract?

    A forward contract is a customized contract between two parties to buy or sell an asset at a specified price on a future date.
  4. Investing

    Calculating Future Value

    Future value is the value of an asset or cash at a specified date in the future that is equivalent in value to a specified sum today.
  5. Managing Wealth

    Dissecting the Simple Interest Formula

    Simple interest ignores the effect of compounding: it's only calculated on the principal amount. This makes it easier to calculate than compound interest.
  6. Investing

    Investing $100 a Month in Stocks for 20 Years

    Learn how a monthly investment of just $100 can help build a future nest egg using properly diversified stocks or stock mutual funds.
  7. Investing

    How to Trade Futures Contracts

    Futures is short for Futures Contracts, which are contracts between a buyer and seller of an asset who agree to exchange goods and money at a future date, but at a price and quantity determined ...
  8. Investing

    What Does Global X Purchase Mean for JP Morgan?

    Discover what JPMorgan Chase gets for its minority interest acquisition of ETF provider Global X, and learn about what it means for the company's ETF business.
  9. Trading

    How To Lock In An Exchange Rate

    Currency risk can be effectively hedged by locking in an exchange rate through the use of currency futures, forwards, options, or exchange-traded funds.
  10. Investing

    Fueling Futures In The Energy Market

    The energy market influences every aspect of our lives, and these four options are its driving force.
RELATED FAQS
  1. Why is the initial value of a forward contract set to zero?

    Discover why the initial value of a forward contract is set to zero; read about financial mathematics and exchange logic ... Read Answer >>
  2. Over what time period should I be looking at the forward rate?

    Read about forward rates and forward prices, how they function, and which rates you should look at based on your own investment ... Read Answer >>
  3. What kinds of derivatives are types of forward commitments?

    Learn more about what a derivative is, what a forward commitment is and which types of derivative securities have forward ... Read Answer >>
  4. What is the difference between a forward rate and a spot rate?

    Learn about spot and forward contracts, how spot and forward rates are used for spot and forward contracts, and the difference ... Read Answer >>
  5. How is a share premium account taxed?

    Understand the difference between a spot rate and forward rate. Learn why someone would enter into a contract with a spot ... Read Answer >>
Hot Definitions
  1. Cover Letter

    A written document submitted with a job application explaining the applicant's credentials and interest in the open position. ...
  2. 403(b) Plan

    A retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers. Generally, retirement ...
  3. Master Of Business Administration - MBA

    A graduate degree achieved at a university or college that provides theoretical and practical training to help graduates ...
  4. Liquidity Event

    An event that allows initial investors in a company to cash out some or all of their ownership shares and is considered an ...
  5. Job Market

    A market in which employers search for employees and employees search for jobs. The job market is not a physical place as ...
  6. Yuppie

    Yuppie is a slang term denoting the market segment of young urban professionals. A yuppie is often characterized by youth, ...
Trading Center