Arbitrage, Replication, and the Cost of Carry in Pricing Derivatives
Free CFA Level I lesson in Derivatives. 10 min read, ~1,498 words.
Arbitrage forces the forward price to equal the cost of buying and carrying the underlying. Direction views never enter. Replication builds the derivative payoff from spot plus financing. The portfolio's cost IS the no-arbitrage price. Fā(T) = Sā Ć (1 + r)^T + FV(storage) ā FV(income), using the risk-free rate...
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What this lesson covers
- Content
- Example 1
- Example 2
- Common Mistakes
- Check Your Understanding
- Exam Shortcuts
Learning objectives
- arbitrage replication and cost of carry
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