ASSIGNMENT – 2

Computation of
Theoretical Future Price
of BHEL Stocks

Geethanjali.C
09AC11

THEORETICAL FUTURES PRICE – DETERMINATION AND COMPARISON

The theoretical futures price is obtained by continuously compounding the spot
price at the cost of carry rate for some time interval. It is an equilibrium price and
any discrepancy would be closed by arbitrage. It is also called fair price/
equilibrium future price.

For BHEL stocks, the theoretical future price is computed and is compared with the
actual future price of the stock. It is analysed for three contracts namely; near month
contract, mid month contract and Far month contract.

Arbitrage arguments apply when the deliverable asset exists in plentiful supply, or
may be freely created. Here, the forward price represents the expected future value
of the underlying discounted at the risk free rate—as any deviation from the
theoretical price will afford investors a riskless profit opportunity and should be
arbitraged away.

Theoretical Future price is computed as follows:

F = S x e rt

Where,

F = Theoretical Future Price to be computed.

S = Spot price prevalent in the Current Market.

r = Interest rate (Risk free interest rate considered, 6.1% for the months June-
August).

t = Time period ( For Near month one month considered, Mid month two months
considered and for far month three months considered).

This relationship may be modified for storage costs, dividends, dividend yields, and
convenience yields.
In a perfect market the relationship between futures and spot prices depends only on
the above variables; in practice there are various market imperfections (transaction
costs, differential borrowing and lending rates, restrictions on short selling) that
prevent complete arbitrage. Thus, the futures price in fact varies within arbitrage
boundaries around the theoretical price.

Contract Type Contract Agreed/Entered Date Contract Expiry Date

Near Month Contract June 1, 2010 June 24, 2010

Mid Month Contract June 1, 2010 July 29, 2010

Far Month Contract June 1, 2010 August 26, 2010

NEAR MONTH FUTURES CONTRACT:

Near Month Contract

2500
2450
2400
2350
2300
2250
2200
2150

Theoretical Future Price Actual Future Price

MID MONTH FUTURES CONTRACT:

 Mid Month Contract
2550
2500
2450
2400
2350
2300
2250
2200
2150

Theoretical Future Price Actual Future Price

FAR MONTH FUTURES CONTRACT:

Far Month Contract

2550

2450

2350

2250

2150
0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
n / 1 n/1 n/1 n/ 1 n/1 n/ 1 l/1 l/1 l/1 l/1 l/1 g /1 g/1 g /1 g/1 g /1
u u u u u
/Ju /Ju /Ju /Ju /Ju /Ju 5/J 9/J 5/J 1/J 7/J /Au /Au /Au /Au /Au
0 1 07 11 1 7 23 2 9 0 0 1 2 2 0 2 06 1 2 18 2 4

Theoretical Future Price Actual Future Price

INTERPRETATION:
Generally, when the Theoretical Future Price of the Stock is more than the Actual

Future Price then the stock is said to be undervalued in the market. In contrast,

when the Theoretical Future Price of the Stock is less than the Actual Future Price

then the stock is said to be overvalued in the market.

When the stock is undervalued, then it is advised that he/she holds the stock or

rather take the long position in the market. Likewise, when the stock is overvalued,

then the investor is advised to take the short position by selling the stocks.

For the considered BHEL stocks, in all the three cases, i.e. near month, mid month

and far month, all the theoretical future prices are lesser than the actual future

prices. Thus, it can be concluded that the stock is overvalued in the market.

Hence, the investor can take Short position by selling the stocks, to earn profit due

to the existence of arbitrage conditions in the market.

DATA AND CALCULATIONS:

Near Month Futures Contract

Date Spot Price Theoretical Actual Difference

Future Price Future Price
01-Jun-10 2314.35 2326.144565 2313.7 12.44456
 02-Jun-10 2321.45 2333.280749 2326.85 6.430749
03-Jun-10 2343.3 2355.242102 2348.9 6.342102
04-Jun-10 2331.8 2343.683495 2339.1 4.583495
07-Jun-10 2270.55 2282.121348 2281.2 0.921348
08-Jun-10 2276.7 2288.30269 2278.2 10.10269
09-Jun-10 2293.05 2304.736014 2295.55 9.186014
10-Jun-10 2324.85 2336.698076 2327.9 8.798076
11-Jun-10 2392.75 2404.944113 2385.2 19.74411
14-Jun-10 2380.25 2392.38041 2389 3.38041
15-Jun-10 2402.05 2414.291508 2410.9 3.391508
16-Jun-10 2392.35 2404.542074 2386.85 17.69207
17-Jun-10 2382.75 2394.89315 2392 2.89315
18-Jun-10 2417.15 2429.468462 2418.4 11.06846
21-Jun-10 2461.3 2473.843463 2455.7 18.14346
22-Jun-10 2433.9 2446.303825 2432.55 13.75382
23-Jun-10 2434.6 2447.007392 2435.5 11.50739
24-Jun-10 2454.5 2467.008808 2455 12.00881

Mid month Futures Contract

Date Spot Price Theoretical Actual Difference

Future Price Future
Price
01-Jun-10 2314.35 2337.999238 2318.8 19.19924
02-Jun-10 2321.45 2345.17179 2329.1 16.07179
03-Jun-10 2343.3 2367.245064 2352.15 15.09506
04-Jun-10 2331.8 2355.627551 2341.75 13.87755
07-Jun-10 2270.55 2293.751667 2288.3 5.451667
08-Jun-10 2276.7 2299.964511 2278.45 21.51451
09-Jun-10 2293.05 2316.481584 2302.95 13.53158
10-Jun-10 2324.85 2348.606533 2329.5 19.10653
11-Jun-10 2392.75 2417.20037 2387.55 29.65037
14-Jun-10 2380.25 2404.572639 2390.35 14.22264
15-Jun-10 2402.05 2426.595403 2416.7 9.895403
16-Jun-10 2392.35 2416.796283 2390.55 26.24628
17-Jun-10 2382.75 2407.098185 2396.8 10.29819
18-Jun-10 2417.15 2441.849702 2427.5 14.3497
21-Jun-10 2461.3 2486.45085 2464.25 22.20085
22-Jun-10 2433.9 2458.770863 2444.55 14.22086
23-Jun-10 2434.6 2459.478016 2448.1 11.37802
24-Jun-10 2454.5 2479.581364 2459 20.58136
25-Jun-10 2451.9 2476.954796 2457.25 19.7048
28-Jun-10 2478.15 2503.473032 2476.5 26.97303
29-Jun-10 2439.45 2464.377575 2449.2 15.17758
30-Jun-10 2459.7 2484.834501 2463.65 21.1845
01-Jul-10 2427.7 2452.507508 2437.15 15.35751
02-Jul-10 2391.9 2416.341685 2406.25 10.09168
05-Jul-10 2359.6 2383.711626 2375.5 8.211626
06-Jul-10 2370.6 2394.82403 2388 6.82403
 07-Jul-10 2371.25 2395.480672 2379.3 16.18067
08-Jul-10 2386.55 2410.937016 2396.75 14.18702
09-Jul-10 2393.55 2418.008545 2397.65 20.35855
12-Jul-10 2444.25 2469.226624 2439.7 29.52662
13-Jul-10 2469.55 2494.785153 2473.9 20.88515
14-Jul-10 2467.8 2493.017271 2466.35 26.66727
15-Jul-10 2438.6 2463.51889 2446.7 16.81889
16-Jul-10 2437.85 2462.761226 2441.95 20.81123
19-Jul-10 2415.5 2440.182842 2418 22.18284
20-Jul-10 2413.8 2438.46547 2409.85 28.61547
21-Jul-10 2406.3 2430.888831 2414.35 16.53883
22-Jul-10 2417.25 2441.950724 2425.2 16.75072
23-Jul-10 2460.2 2485.33961 2453.8 31.53961
26-Jul-10 2471.35 2496.603546 2464 32.60355
27-Jul-10 2449.55 2474.580783 2450.2 24.38078
28-Jul-10 2461.35 2486.501361 2454.4 32.10136
29-Jul-10 2461.9 2487.056981 2461.55 25.50698

Far month Futures Contract

Date Spot Price Theoretical Actual Difference

Future Price Future Price
01-Jun-10 2314.35 2349.914326 2326.1 23.81433
02-Jun-10 2321.45 2357.123431 2326.1 31.02343
03-Jun-10 2343.3 2379.309197 2326.1 53.2092
04-Jun-10 2331.8 2367.632478 2340 27.63248
07-Jun-10 2270.55 2305.441257 2340 -34.5587
08-Jun-10 2276.7 2311.685763 2303.9 7.785763
09-Jun-10 2293.05 2328.287012 2303.9 24.38701
10-Jun-10 2324.85 2360.575678 2303.9 56.67568
11-Jun-10 2392.75 2429.519089 2393.95 35.56909
14-Jun-10 2380.25 2416.827003 2393.95 22.877
15-Jun-10 2402.05 2438.962001 2393.95 45.012
16-Jun-10 2392.35 2429.112942 2393.95 35.16294
17-Jun-10 2382.75 2419.36542 2393.95 25.41542
18-Jun-10 2417.15 2454.294041 2430 24.29404
21-Jun-10 2461.3 2499.122488 2473.7 25.42249
22-Jun-10 2433.9 2471.301436 2473.7 -2.39856
23-Jun-10 2434.6 2472.012193 2460 12.01219
24-Jun-10 2454.5 2492.217994 2428.3 63.91799
25-Jun-10 2451.9 2489.57804 2463.7 25.87804
28-Jun-10 2478.15 2516.23142 2481.2 35.03142
29-Jun-10 2439.45 2476.936722 2453.7 23.23672
30-Jun-10 2459.7 2497.497901 2468.25 29.2479
01-Jul-10 2427.7 2465.006161 2441.15 23.85616
02-Jul-10 2391.9 2428.656027 2410.95 17.70603
05-Jul-10 2359.6 2395.859677 2379.2 16.65968
06-Jul-10 2370.6 2407.028713 2392.1 14.92871
07-Jul-10 2371.25 2407.688701 2383.95 23.7387
 08-Jul-10 2386.55 2423.223815 2406.35 16.87381
09-Jul-10 2393.55 2430.331383 2410 20.33138
12-Jul-10 2444.25 2481.810483 2443.7 38.11048
13-Jul-10 2469.55 2507.499265 2479.8 27.69927
14-Jul-10 2467.8 2505.722373 2470.8 34.92237
15-Jul-10 2438.6 2476.07366 2452.15 23.92366
16-Jul-10 2437.85 2475.312135 2446.15 29.16214
19-Jul-10 2415.5 2452.618686 2422.5 30.11869
20-Jul-10 2413.8 2450.892562 2417.4 33.49256
21-Jul-10 2406.3 2443.27731 2420.75 22.52731
22-Jul-10 2417.25 2454.395578 2432.25 22.14558
23-Jul-10 2460.2 2498.005585 2463.55 34.45558
26-Jul-10 2471.35 2509.326926 2474.45 34.87693
27-Jul-10 2449.55 2487.191928 2459.5 27.69193
28-Jul-10 2461.35 2499.173257 2462.5 36.67326
29-Jul-10 2461.9 2499.731709 2475.55 24.18171
30-Jul-10 2437.9 2475.362904 2450.45 24.9129
02-Aug-10 2453.8 2491.507237 2462.95 28.55724
03-Aug-10 2467.65 2505.570068 2471.5 34.07007
04-Aug-10 2518.6 2557.30301 2513.1 44.20301
05-Aug-10 2524.9 2563.699822 2522.2 41.49982
06-Aug-10 2507.6 2546.133975 2503 43.13397
09-Aug-10 2530.25 2569.132034 2525.8 43.33203
10-Aug-10 2499.75 2538.163345 2500.25 37.91334
11-Aug-10 2498.75 2537.147978 2485.9 51.24798
12-Aug-10 2492.95 2531.25885 2488 43.25885
13-Aug-10 2496.75 2535.117244 2488.8 46.31724
16-Aug-10 2468.85 2506.788508 2475.75 31.03851
17-Aug-10 2475.15 2513.18532 2473.1 40.08532
18-Aug-10 2472.2 2510.189987 2472.8 37.38999
19-Aug-10 2478.95 2517.043714 2473.45 43.59371
20-Aug-10 2469.5 2507.448497 2472.65 34.7985
23-Aug-10 2509.8 2548.367782 2501 47.36778
24-Aug-10 2483.65 2521.815938 2488 33.81594
25-Aug-10 2467.15 2505.062385 2466.4 38.66238
26-Aug-10 2487.25 2525.471259 2487 38.47126