Article - 4: Commodity forwards a notes to Robert McDonald

Article – 4:  Commodity forwards and Futures. (Robert McDonald)   

What will be the impact of the following parameters on long forward position and short forward position.	The person agreed to buy in future (long in forward market)	The person agreed to sell in future (short in forward market)
Dividends income or yield	The investor, who is willing to buy an asset in future, will reduce that value of compensation from the future price of the asset.	The dividend in the hands of the holder of the asset is an income. By holding the asset, the seller is already compensated.
Cost of holding the asset	In the future value of the asset, the buyer needs to add those expenses in the future value.	The cost of holding an asset is an expense. The seller expects that buyer in future will compensate.
Points to be noted in pricing forwards: 1.       The trader with short forward position (agreed to sell in futures) will include all the expenses in his forward pricing. Let us assume he is holding the asset as of now. 2.       The trader with long forward position agrees to pay all the expenses incurred by the trader with short forward position. 3.       The trader with short forward position (holding the asset and willing to sell in future) receives income by holding the asset (already discussed as dividend yield). 4.       The trader with long forward position will reduce the future price with an a rate equal to dividend yield.
Look at the following example for more clarity: An investor is holding an asset and agreed to sell in future Present price of a commodity $50.00 (Spot price - S0) The risk-free rate of interest in the market (for one year) 4.5%  (risk free rate –r) The cost incurred to hold the asset $5.00 ( by the end of the year) The asset is expected to pay $3.00 as dividend income to the holder of the asset by the end of the year. The value of investment, on the basis of risk free rate for the holder of the asset by the end of the year S0ert  = $50 x e(0.045x1 yr) = $52.30 (This is the time value of investment for the investor who is already holding the asset) The forward price of the asset, if the holder agrees to sell after one year $52.30 + $5.00 - $3.00 = $54.30