** The Role of Futures Prices (Non-Commodity Markets)**

Contrary to what some may believe – futures prices are **not a forecast** of what the index price is going to be for the contract month. In truth, Futures prices are a mathematical calculation using key variables:

- the prevailing interest rate (usually the risk-free rate),
- time to contract expiration (often assuming a 360-day year),
- and, for certain assets like stocks, the dividend yield.

**The Formula Behind Futures Pricing**

The formula for calculating futures prices is as follows:

*Futures Price = Spot Price * (1 + r ^(x/360)) – Dividend Yield*- Spot Price: The current market price.
- ‘r’ (Interest Rate): The relevant interest rate, often the risk-free rate.
- ‘x’ (Time to Expiration): The time remaining until the futures contract expires, often assuming a 360-day year.
- Dividend Yield: Accounts for income generated by the asset, particularly relevant for assets like stocks.

This formula serves a fundamental purpose by enforcing **arbitrage-free pricing**

**Futures Pricing: A Simple Example**

Let’s consider a practical example involving a $100 stock with a one-year futures contract:

- Scenario 1: 5% Interest Rate
- When the current interest rate is 5%, the futures price is $105.

- Scenario 2: 6% Interest Rate
- If interest rates rise to 6%, the futures price increases to $106 due to the higher opportunity cost of tying up funds.

- Scenario 3: 4% Interest Rate
- Conversely, if interest rates drop to 4%, the futures price falls to $104 because the opportunity cost decreases.

## In Summary

In essence, futures prices are mathematically derived to ensure fairness in the market, considering factors such as interest rates, timeframes, and, where applicable, dividend yields or other relevant factors.

Category: Derivatives