# Understanding Forward Price: Definition, Calculation Formulas, and Examples

## What Is a Forward Price?

Forward price is the agreed-upon future delivery price in a forward contract for commodities, currencies, or financial assets. It's crucial for buyers and sellers seeking to hedge against market fluctuations. Using specific formulas based on current spot prices and carrying costs, the forward price helps neutralize a contract's initial value, while market dynamics later influence its positive or negative shifts.

### Key Takeaways

*   Forward price is the agreed-upon price for delivering an asset at a future date and is affected by the spot price and carrying costs.
*   The forward price formula utilizes the spot price, risk-free interest rate, and carrying costs, allowing investors to hedge against market volatility.
*   Understanding forward contracts helps investors manage risk, but it also carries potential downsides such as unfavorable price movements.
*   Dividends impact forward pricing calculations, requiring adjustments to account for the present value of expected dividends over the contract's life.

![Forward Price: The predetermined delivery price of a forward contract.](https://www.investopedia.com/thmb/C8RCXGMCiMfhgUlhpkExPGWBSiA=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Forwardprice_final-0def8a52ff8a42718551ccb159f0f302.png)

*— Investopedia / Michela Buttignol*

## Understanding Forward Price: Key Concepts

Forward price is based on the current [spot price](https://www.investopedia.com/terms/s/spotprice.asp) of the underlying asset, plus any carrying costs such as interest, storage costs, foregone interest, or other costs, including [opportunity costs](https://www.investopedia.com/terms/o/opportunitycost.asp).

While the contract starts with no [intrinsic value](https://www.investopedia.com/terms/i/intrinsicvalue.asp), it can gain or lose value over time. Offsetting positions in a forward contract are equivalent to a [zero-sum game](https://www.investopedia.com/terms/z/zero-sumgame.asp). For example, if one investor takes a long position in a pork belly forward agreement and another investor takes the [short position](https://www.investopedia.com/terms/s/short.asp), any gains in the long position equals the losses that the second investor incurs from the short position. Setting the contract's initial value to zero ensures both parties start on equal ground.

## Example of Calculating Forward Price

When the underlying asset in the forward contract does not pay any [dividends](https://www.investopedia.com/terms/d/dividend.asp), the forward price can be calculated using the following formula:

$\begin{aligned} &F = S \times e ^ { (r \times t) } \\ &\textbf{where:} \\ &F = \text{the contract's forward price} \\ &S = \text{the underlying asset's current spot price} \\ &e = \text{the mathematical irrational constant approximated} \\ &\text{by 2.7183} \\ &r = \text{the risk-free rate that applies to the life of the} \\ &\text{forward contract} \\ &t = \text{the delivery date in years} \\ \end{aligned}$

For example, assume a security is currently trading at $100 per unit. An investor wants to enter into a forward contract that expires in one year. The current annual risk-free interest rate is 6%. Here's how to calculate the forward price using the formula:

$\begin{aligned} &F = \$100 \times e ^ { (0.06 \times 1) } = \$106.18 \\ \end{aligned}$

If there are carrying costs, that is added into the formula:

$\begin{aligned} &F = S \times e ^ { (r + q) \times t } \\ \end{aligned}$

Here, q is the carrying costs.

If the underlying asset pays dividends over the life of the contract, the formula for the forward price is:

$\begin{aligned} &F = ( S - D ) \times e ^ { ( r \times t ) } \\ \end{aligned}$

Here, D equals the sum of each dividend's present value, given as:

$\begin{aligned} D =& \ \text{PV}(d(1)) + \text{PV}(d(2)) + \cdots + \text{PV}(d(x)) \\ =& \ d(1) \times e ^ {- ( r \times t(1) ) } + d(2) \times e ^ { - ( r \times t(2) ) } + \cdots + \\ \phantom{=}& \ d(x) \times e ^ { - ( r \times t(x) ) } \\ \end{aligned}$

Using the example above, assume that the security pays a 50-cent dividend every three months. First, the present value of each dividend is calculated as:

$\begin{aligned} &\text{PV}(d(1)) = \$0.5 \times e ^ { - ( 0.06 \times \frac { 3 }{ 12 } ) } = \$0.493 \\ \end{aligned}$

$\begin{aligned} &\text{PV}(d(2)) = \$0.5 \times e ^ { - ( 0.06 \times \frac { 6 }{ 12 } ) } = \$0.485 \\ \end{aligned}$

$\begin{aligned} &\text{PV}(d(3)) = \$0.5 \times e ^ { - ( 0.06 \times \frac { 9 }{ 12 } ) } = \$0.478 \\ \end{aligned}$

$\begin{aligned} &\text{PV}(d(4)) = \$0.5 \times e ^ { - ( 0.06 \times \frac { 12 }{ 12 } ) } = \$0.471 \\ \end{aligned}$

The sum of these is $1.927. This amount is then plugged into the dividend-adjusted forward price formula:

$\begin{aligned} &F = ( \$100 - \$1.927 ) \times e ^ { ( 0.06 \times 1 ) } = \$104.14 \\ \end{aligned}$

## What Is the Difference Between Forward Price and Spot Price?

Forward price refers to a predetermined future delivery price for an underlying commodity, currency, or financial asset agreed upon by the buyer and seller of a forward futures contract. In contrast, a spot price refers to the asset’s current market price. 

## Why Do Some Investors Want to Lock in a Forward Price?

Investors may want to lock in a forward price to [hedge](https://www.investopedia.com/terms/h/hedge.asp) against future market fluctuations. For example, a farmer may want to use a forward wheat contract ahead of harvest to protect against a decline in grain prices caused by potential drought or flood.

## What Are the Drawbacks of Locking in a Forward Price?

The downside of locking in a forward price is that the asset's value could drop, leading to a loss compared to selling at the spot price. Furthermore, a [longer-dated](https://www.investopedia.com/terms/l/long-date-forward.asp#:~:text=A%20long%2Ddated%20forward%20is%20an%20OTC%20derivatives%20contract%20that,a%20few%20years%20from%20now.) forward price contact increases the risk of non-payment or default.

## What Are the Main factors That Determine an Asset’s Forward Price?

Investors determine an asset's forward price based on its current spot price plus carrying costs such as storage, transportation, opportunity costs, and foregone interest. Typically, these costs will be higher for forward contracts that have longer expiry dates.

## The Bottom Line

The forward price is a critical component in financial contracts, allowing buyers and sellers to lock in the delivery price of an asset for a future date. While this can provide protection against market fluctuations, it also carries risks, including potential unfavorable movement of asset values and default risk for longer contracts. Calculating the forward price involves current spot prices, risk-free interest rates, and potentially carrying costs or dividends. Investors should thoroughly understand these elements, as they can influence decisions and financial outcomes significantly.