Not that easy to develop an intuitive understanding…
Q2.46 [[Heard on the street]]. Suppose the 2 properties both sell for $1m today. What about delivery in x months? Suppose the beach generates an expected (almost-guaranteed) steady income (rental or dividend) of $200k over this period. Suppose there’s negligible inflation over this (possibly short) period.
Paradox: you may feel after x months, the beach would have a spot price around $1m or higher, since everyone knows it can generate income.
%%A: there’s no assurance about it. It could be much lower. I feel this is counter-intuitive. There might be war, or bad weather, or big change in supply/demand over x months. Our calculation here is based solely on the spot price now and the dividend rate, not on any speculation over price movements.
I guess the fair “indifferent” price both sides would accept is $800k, i.e. in x months, this amount would change hand.
– If seller asks $900k forward, then buyer would prefer spot delivery at $1m, since after paying $1m, she could receive $200k dividends over x months, effectively paying $800k.
– If buyer bids $750k forward, then seller would prefer spot delivery.
What would increase fwd price?
* borrowing interest Cost. For a bond, this is not the interest earned on the bond
* storage Cost
What would decrease fwd price?
* interest accrual Income
* dividend Income