Forward prices for an idle field and a rented beach
Question
Two plots of land are each worth $1 million today: a field that produces no income, and a beach property that generates rental income. Which has the higher forward price for delivery in one year?
Short answer
The idle field. A forward price is the spot price carried forward at the risk-free rate, minus the future value of any income the owner receives before delivery: . The beach owner keeps its income during the year, so its forward price is lower (ignoring maintenance or carrying costs).
Adapted from Crack, Heard on the Street, Q2.46, p.31; question and answer rewritten by SelfMadeQuant.com.
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Open the worked solutionLessons behind this question
- Forward and Futures Prices: Cost-of-Carry, Known Income, and Continuous Yields
- Bond Prices, Discount Factors, and the Law of One Price
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