As an SEO copy editor, it is important to understand the intricacies of various financial instruments. In this article, we will discuss how to calculate the fair value of a future contract.

First, let us understand what a future contract is. A future contract is an agreement between two parties to buy or sell an underlying asset at a predetermined price, at a future date. The underlying asset could be a commodity, a financial instrument or a currency. Future contracts are traded on exchanges, and the price of the contract is determined by the demand and supply forces of the market.

Now, let us understand how to calculate the fair value of a future contract. The fair value of a future contract is the theoretical price at which the contract should be trading, based on the current market conditions. The fair value takes into account various factors such as the current price of the underlying asset, the time left until the expiration of the contract, the interest rate and the dividends (if any), and the cost of carry (which includes storage costs, insurance costs, etc).

To calculate the fair value of a future contract, you need to use a mathematical formula. The formula is as follows:

Fair Value = Spot Price x (1 + Interest Rate)T – Dividends – Cost of Carry

Where:

Spot Price = the current price of the underlying asset

Interest Rate = the interest rate prevailing in the market

T = Time left until the expiration of the contract (in years)

Dividends = any dividends paid on the underlying asset during the life of the contract

Cost of Carry = the cost of carrying the underlying asset until the expiration of the contract

Let us take an example to better understand how to use this formula. Suppose you want to calculate the fair value of a future contract on gold. The current spot price of gold is $1,800 per ounce, the interest rate is 3%, there are 6 months left until the expiration of the contract, there are no dividends, and the cost of carry is $20 per ounce.

Using the formula, we get:

Fair Value = $1,800 x (1 + 0.03)0.5 – 0 – $20 = $1,834.31

Therefore, the fair value of the future contract for gold is $1,834.31.

In conclusion, calculating the fair value of a future contract is important for traders and investors as it helps them make informed decisions based on the current market conditions. By understanding the formula and the factors that go into it, you can become better equipped to make profitable trades in the futures market.