The price and value are different concepts for forward, futures and swap contracts as compared to stocks, bonds, and options. In the case of stock, the value is calculated using some of the pricing models like dividend discount model, price multiples models and then that value is compared with the current market price. If there is a wide disparity in the value and price, then the appropriate position is taken in the hope that the price will converge to the value of the stock eventually. The same is true with the options. The price is the market price of the option, and the value is calculated using any of the option pricing models, and then both are compared.
In the case of forwards, futures, and swaps, the price is one of the terms the parties agreed on when they created the contract. It is the price the two parties agree will be paid at a future date for the underlying. The price remains fixed during the contract period, and it is decided at the contract initiation. In these contracts, no money is paid at the beginning unlike options, stocks, and bonds.
The value of the contract changes as the underlying price moves. The value is the amount of wealth represented by owning the forward, futures, or swap contract. For example, you enter into a forward contract for a stock for a price of $100 from the long side of the contract. That means that you will be buying the underlying at the end of expiration (assume that to be one year) for $100. Assuming the risk-free rate to be 5 percent. The present value of $100 is equal to $95.24. Now, depending on the movement of the underlying, the value of the contract will change. If the spot price of the underlying moves to $98. Then your position will have a value of $2.76 (=98-95.24) because you can effectively buy the underlying at $95.24 and sell that at a current market price of $98.
Check your concepts:
(58.5) Which of the following derivative instruments is least likely to differentiate between the price and the value?
(a) Futures
(b) Swaps
(c) Options
(58.6) Which of the following remains constant during the contract period for a forward contract?
(a) Price
(b) Value
(c) Both price and value
Solutions:
(58.5) Correct Answer is C: Options have the same price and the value. If the price and value differ, then there is an arbitrage opportunity. Forwards, futures, and swaps have different price and value.
(58.6) Correct Answer is A: The price remains constant for the forward contract and is set at the initiation of the contract. The value of the forward contract keeps on changing with the change in the underlying.
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