Unit study guide · NISM Series VIII
Forwards and Futures
9 questions in this unit
What this unit covers
- A company wants a contract tailored to an unusual quantity and a non-standard settlement date negotiated directly with one counterparty. Which instrument is structurally more suited to that requirement?
- Nifty spot is 24,000. Assume no dividends, a simple annual financing rate of 6%, and exactly 30 days to expiry using a 365-day year. Ignoring transaction costs, the theoretical futures value is closest to:
- Using the NISM convention that basis = spot price − futures price, a share is at ₹512 in the cash market and its futures contract is at ₹519. What is the basis?
- A futures contract is trading at a premium to the current spot price, producing an upward-sloping futures relationship under the usual terminology. This condition is called:
- As an equity futures contract approaches expiry, what should happen to a persistent difference between its futures price and the corresponding spot price, other things being equal?
- A share trades at ₹1,200. A dividend with a present value of ₹8 is due before expiry. With a simple financing rate of 6% a year, 90 days to expiry and a 360-day year, what is the theoretical futures price?
- A non-dividend-paying share is at ₹800 and its no-arbitrage futures value is ₹812, but the quoted futures price is only ₹790. Ignoring costs and assuming the share can be borrowed and sold short, which trade is consistent with reverse cash-and-carry arbitrage?
- Under a simple expectations view of futures pricing, what is the central idea?
- A company wants to exit a customised bilateral forward before maturity but cannot easily find a willing replacement counterparty on identical terms. Which drawback of forwards does this illustrate?
Key ideas
From the practice bank · 1
A company wants a contract tailored to an unusual quantity and a non-standard settlement date negotiated directly with one counterparty. Which instrument is structurally more suited to that requirement?
A forward contract can be customised bilaterally, including its quantity and maturity terms. Exchange-traded futures are standardised according to exchange contract specifications. Remember: Customisation is a key advantage of forwards. Standardisation and exchange trading are key characteristics of futures.
Hint Common mistake: Assuming futures can be customised merely because a trader can choose how many contracts to trade.
VIII-012From the practice bank · 2
Nifty spot is 24,000. Assume no dividends, a simple annual financing rate of 6%, and exactly 30 days to expiry using a 365-day year. Ignoring transaction costs, the theoretical futures value is closest to:
With no dividends and simple financing, F ≈ S × [1 + r × (days/365)]. Thus F ≈ 24,000 × [1 + 0.06 × (30/365)] = 24,118.36, so 24,118 is closest. Remember: Under a simple no-dividend cost-of-carry setup, fair futures value is spot plus the financing cost for the remaining time.
Hint Common mistake: Applying the full annual interest rate to a contract with only a fraction of a year remaining.
VIII-013From the practice bank · 3
Using the NISM convention that basis = spot price − futures price, a share is at ₹512 in the cash market and its futures contract is at ₹519. What is the basis?
Basis = spot − futures = ₹512 − ₹519 = −₹7. The negative sign indicates that the futures price is above the spot price under this convention. Remember: Always check the stated basis convention. In the NISM FAQ convention, basis is cash/spot price minus futures price.
Hint Common mistake: Using futures minus spot automatically even when the question specifies spot minus futures.
VIII-014From the practice bank · 4
A futures contract is trading at a premium to the current spot price, producing an upward-sloping futures relationship under the usual terminology. This condition is called:
Contango describes a market condition in which futures prices are above the spot price, commonly reflecting positive net cost of carry. Backwardation is the opposite relationship. Remember: Contango: futures above spot. Backwardation: futures below spot, using the standard terminology.
Hint Common mistake: Reversing contango and backwardation.
VIII-015From the practice bank · 5
As an equity futures contract approaches expiry, what should happen to a persistent difference between its futures price and the corresponding spot price, other things being equal?
The spot-futures price difference normally narrows as approaches because the remaining cost of carry diminishes and arbitrage pressures discourage a material price gap at maturity. This is the convergence principle. Remember: Time to expiry shrinks toward zero, so the sustainable spot-futures gap also tends toward zero.
Hint Common mistake: Thinking a futures premium or discount present today must survive unchanged until expiry.
VIII-016From the practice bank · 6
A share trades at ₹1,200. A dividend with a present value of ₹8 is due before expiry. With a simple financing rate of 6% a year, 90 days to expiry and a 360-day year, what is the theoretical futures price?
First reduce spot by the present value of the known dividend: ₹1,200 − ₹8 = ₹1,192. The financing period is 90/360 = 0.25 year, so the carry factor is 1 + 0.06 × 0.25 = 1.015. Therefore the theoretical futures value is ₹1,192 × 1.015 = ₹1,209.88. Remember: Known dividends expected before expiry reduce fair futures value relative to an otherwise identical no-dividend contract.
Hint Common mistake: Adding the dividend to spot instead of subtracting its present value before applying carry.
VIII-026From the practice bank · 7
A non-dividend-paying share is at ₹800 and its no-arbitrage futures value is ₹812, but the quoted futures price is only ₹790. Ignoring costs and assuming the share can be borrowed and sold short, which trade is consistent with reverse cash-and-carry arbitrage?
The futures is underpriced relative to its no-arbitrage value. The reverse cash-and-carry direction is to sell/short the relatively expensive spot asset and buy the relatively cheap futures contract, subject to the feasibility and cost assumptions stated in the question. Remember: Underpriced futures point to reverse cash-and-carry: short spot and buy futures, when shorting is feasible.
Hint Common mistake: Choosing the arbitrage direction from the absolute futures price rather than comparing it with fair value.
VIII-027From the practice bank · 8
Under a simple expectations view of futures pricing, what is the central idea?
The expectations approach links futures prices conceptually to market expectations about future spot prices. It is not a guarantee: risk premia, carry considerations and changing information mean the realised future spot price can differ from today's futures quote. Remember: A pricing model or market expectation is not a promise about the realised future spot price.
Hint Common mistake: Treating futures price as a guaranteed forecast.
VIII-108From the practice bank · 9
A company wants to exit a customised bilateral forward before maturity but cannot easily find a willing replacement counterparty on identical terms. Which drawback of forwards does this illustrate?
Customisation can make a forward fit a user's needs, but the same custom terms can reduce secondary-market and make early termination or transfer more difficult than closing a liquid exchange-traded futures contract. Remember: The benefits of OTC customisation come with trade-offs such as counterparty risk and potentially weaker liquidity.
Hint Common mistake: Seeing customisation as an advantage without considering exit difficulty.
VIII-109Expiry day is the last day on which a derivative contract can be traded.
Read moreLiquidity describes how easily a given quantity can be traded.
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