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I would assume that increases in any dividends would increase the price of the underlying security, therefore causing a relative increase to the security future price. Or is this relationship more like that of interest rates and bond prices?

My textbook states that any dividend increase in the underlying security would cause a decrease relative to the price of the underlying stock.

Thanks in advance for your responses.

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The owner of a long futures contract does not receive dividends, hence this is a disadvantage compared to owning the underlying stock. If the dividend is increased, and the future price would not change, there is an arbitrage possibility.

For the sake of simplicity, assume that the stock suddenly starts paying a dividend, and that the risk free rate is zero (so interest does not play a role). One can expect that the future price is (rougly) equal to the stock price before the dividend announcment. If the future price would not change, an investor could buy the stock, and short a futures contract on the stock. At expiration he has to deliver the stock for the price set in the contract, which is under the assumptions here equal to the price he bought the stock for. But because he owned the stock, he receives the announced dividend. Hence he can make a risk-free profit consisting of the divivends.

If interest do play a role, the argument is similar.

  • Excellent. I forgot that in normal markets the cash position is typically higher than the correlated futures position due to the dividend payments. Thank you! – PipAdvisor Mar 2 '14 at 17:05
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The price of a future with an underlying that pays dividends is

enter image description here

As you can see, since the value of dividends is subtracted from the value of the underlying equity, the future's price is lowered if dividends rise.

Compounding that effect with the dividend effect on equity prices, reducing their prices, the future should suffer more.

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