Premium / Discount
If you're watching financial futures, you'll be aware the FTSE 100 appears in two incarnations.
- The FTSE 100 - the underlying index of the 'cash index' - this is the one which is widely quoted on television and in newspapers etc.
- The FTSE 100 Futures. This is an established series of contracts which essentially allow you to use the markets to bet on future movements in the index.
The theoretical relationship between the FTSE 100 cash and FTSE 100 futures is governed by the dividend flow out of the 100 companies which make up the index, and the current rate of interest.
When the futures price trades at a level above/below this theoretical level the futures market is described as being at a premium/discount to " fair value " (see below).
Terms such as "the tail wagging the dog" originate from a tendency for the futures activity to determine the performance of the equity market.
For example if there is strong buying on the futures market, where no stamp duty is payable, dealing costs are lower and large size execution can be fast, an institutional investor may prefer to start moving the market higher. The underlying shares will be marked up as a result.