Price futures and forwards from spot, carry, income, and basis, and recognize when fair value supports a hedge or arbitrage decision.
Underlying assets, fair value, and futures pricing appears in the official CIRO Derivatives Exam syllabus as part of Derivative pricing. Questions here usually test whether you can move from a spot-market fact pattern to the correct futures logic without confusing fair value, settlement mechanics, and arbitrage language.
The key pricing idea is simple: a futures or forward price starts from the current value of the underlying and then adjusts for the economic cost or benefit of carrying that position to expiry. Financing costs, storage, insurance, and other holding costs push fair value up. Cash flows or benefits from holding the underlying, such as income or convenience yield, pull fair value down.
A practical exam-ready version is:
$$ F_0 \approx S_0 + \text{carry costs} - \text{benefits from holding the asset} $$
You do not need every pricing question to look identical. Some questions give financing and storage separately. Others give a net carry adjustment. The better answer identifies which items belong in carry and which ones offset it.
Candidates often blur two ideas that belong in different boxes. Fair value asks where the futures price should trade based on spot and carry. Mark to market asks how gains and losses are settled through time as the contract price changes.
That matters because a question can mention both. If you are asked how a contract should be priced, think fair value. If you are asked how cash moves through the account as prices change, think marking to market and margin variation.
Basis is the difference between the cash-market price and the derivative price. A simple expression is:
$$ \text{Basis} = S - F $$
At expiry, that difference should converge toward zero. Before expiry, basis can move. That is why hedges reduce risk without always eliminating it. If the cash exposure and the futures contract do not line up perfectly in timing, quality, or delivery terms, basis risk remains.
| Situation | What you should think first | Why |
|---|---|---|
| Futures price seems too high relative to spot and carry | Cash-and-carry arbitrage or overpricing | The market may be paying more than justified by carrying the underlying |
| Futures price seems too low relative to spot and carry | Reverse cash-and-carry logic or underpricing | The derivative may be cheap relative to the synthetic alternative |
| A hedge underperforms even though direction was correct | Basis risk or contract mismatch | Direction alone does not guarantee a perfect hedge |
| A margin account changes daily as futures move | Mark to market | Settlement mechanics are separate from initial fair-value logic |
The stronger answer usually separates three questions cleanly: what the future should be worth, how the hedge behaves before expiry, and how daily settlement changes the account. When the case mixes those ideas, classify the pricing job before you calculate.