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For CFA® Level I, the cost of carry links today’s spot price to a no-arbitrage forward or futures price: financing and holding costs raise the delivery price, while benefits from owning the asset reduce it. That price is derived from a replication argument, not from a forecast of where spot will trade at delivery. A futures price may differ from its comparable forward price when daily settlement interacts with changing interest rates.
Why carrying the asset sets a price
A forward buyer can arrange to receive an asset later, or buy it now and finance the purchase until delivery. If both routes give the same asset at the same date, their costs should align under the stated assumptions. CFA Institute explains this replication principle in its derivatives reading. Holding costs such as storage add to the financed spot cost; cash income or other ownership benefits pull the delivery price down.
For an asset with no income or storage cost, and an effective annual financing rate that is fixed over the term, the simple spot-to-forward relationship is:
A futures contract settles gains and losses daily. CFA Institute’s futures valuation reading notes that this cash-flow pattern can produce a forward–futures price difference when interest rates vary and co-move with futures prices. With deterministic rates in the example below, that complication drops out.
One illustrative year of carry
Take a fictional asset priced at £100 today. Assume an effective annual financing rate of 5%, one year to delivery, no storage cost, no income or other ownership benefit, and deterministic interest rates. These are illustrative inputs, not observed market prices or rates.
- Buying the asset now costs £100. Financing it for the year requires £105 at delivery.
- A forward delivery price of £105 matches that financed purchase. Under the assumed deterministic rates, the corresponding futures price is also £105.
- A quoted delivery price above £105 would favour the buy-spot-and-finance route over the contract route before transaction costs and other frictions. A price below £105 reverses that comparison.
The £5 gap between spot and the calculated delivery price is the financing cost for this example. It does not say that the asset is expected to trade at £105 in a year. The realised spot price then can be higher or lower; the calculation fixes the cost of obtaining the asset through two equivalent routes today.
Keep the two common shortcuts separate
- Forecast shortcut. Calling the calculated futures price an expected future spot price confuses a cost-based relation with a prediction.
- Contract shortcut. Treating forwards and futures as always identical ignores the effect of futures’ daily settlement when rates are uncertain. State the rate assumption before using the same numerical price for both.
For a wider revision path, see the CFA programme overview and the study methodology. Practise identifying each carry component before choosing a pricing relationship.
Sources
- Arbitrage, Replication, and the Cost of Carry in Pricing Derivatives | CFA Institute · cfainstitute.org · Retrieved
- Pricing and Valuation of Futures Contracts | CFA Institute · cfainstitute.org · Retrieved
