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## Sunday, June 7, 2015

### fwd price@beach^desert - intuitive

Not that easy to develop an intuitive understanding...

Q2.46 [[Heard on the street]]. Suppose the 2 properties both sell for \$1m today. What about delivery in x months? Suppose the beach generates an expected (almost-guaranteed) steady income (rental or dividend) of \$200k over this period. Suppose there's negligible inflation over this (possibly short) period.

Paradox: you may feel after x months, the beach would have a spot price around \$1m or higher, since everyone knows it can generate income.
%%A: there's no assurance about it. It could be much lower. I feel this is counter-intuitive. There might be war, or bad weather, or big change in supply/demand over x months. Our calculation here is based solely on the spot price now and the dividend rate, not on any speculation over price movements.

I guess the fair "indifferent" price both sides would accept is \$800k, i.e. in x months, this amount would change hand.
- If seller asks \$900k forward, then buyer would prefer spot delivery at \$1m, since after paying \$1m, she could receive \$200k dividends over x months, effectively paying \$800k.
- If buyer bids \$750k forward, then seller would prefer spot delivery.

What would increase fwd price?
* borrowing interest Cost. For a bond, this is not the interest earned on the bond
* storage Cost

What would decrease fwd price?
* interest accrual Income
* dividend Income

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