Pricing Derivatives

Pricing derivatives – forwards, futures, FRAs, and swaps – is generally not difficult, and the principle that underlies all pricing relationships is quite easy: arbitrage.

The first thing you need to know is exactly what is meant by the price of a derivative. The price of:

• A forward/futures contract is the agreed price of the underlying at the expiration of the contract
• An FRA is the agreed fixed rate
• A swap is the agreed fixed rate (note that in a fixed-for-fixed currency swap there are two prices, and in a floating-for-floating currency swap or a floating-for-equity swap there is no price)

Here are links to articles on pricing derivatives:

[menu name = “Level II Pricing Derivatives Articles”]

Also note that the formulae used for pricing derivatives will vary depending on whether the risk-free interest rate is given as an effective rate or a nominal rate; for a refresher on nominal vs. effective interest rates, look here.