Example of How Forward Prices Should Be Agreed Upon
Continuing on the example above, suppose now that the initial price of Andy's house is $100,000 and that Bob enters into a forward contract to buy the house one year from today. But since Andy knows that he can immediately sell for $100,000 and place the proceeds in the bank, he wants to be compensated for the delayed sale. Suppose that the risk free rate of return R (the bank rate) for one year is 4%. Then the money in the bank would grow to $104,000, risk free. So Andy would want at least $104,000 one year from now for the contract to be worthwhile for him – the opportunity cost will be covered.
Read more about this topic: Forward Contract
Famous quotes containing the words agreed upon, prices and/or agreed:
“Playing games with agreed upon rules helps children learn to live by rules, establish the delicate balance between competition and cooperation, between fair play and justice and exploitation and abuse of these for personal gain. It helps them learn to manage the warmth of winning and the hurt of losing; it helps them to believe that there will be another chance to win the next time.”
—James P. Comer (20th century)
“The earth only has so much bounty to offer and inventing ever larger and more notional prices for that bounty does not change its real value.”
—Ben Elton (b. 1959)
“There is between sleep and us something like a pact, a treaty with no secret clauses, and according to this convention it is agreed that, far from being a dangerous, bewitching force, sleep will become domesticated and serve as an instrument of our power to act. We surrender to sleep, but in the way that the master entrusts himself to the slave who serves him.”
—Maurice Blanchot (b. 1907)