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What is Forward Pricing?

Charity Delich
Charity Delich

Forward pricing is a common stock pricing method used by investment companies and funds that buy and sell open-end mutual fund stock. In a forward pricing agreement, a mutual fund typically sets the price of its shares according to the net asset value (NAV) of the shares following the receipt of an order to buy or sell the shares. In general, a fund sets the net asset value of its stock on a daily basis, after the close of major stock exchanges.

Forward pricing comes about because the net asset value of open-end mutual fund stock is generally recalculated after the stock market closes on a trading day. If an order to purchase mutual fund shares is placed after the fund’s net asset value pricing time occurs, the fund cannot price the order at the prior day’s net asset value. As a result, the fund usually engages in forward pricing and sells the stock according to the next day’s net asset value.

Man climbing a rope
Man climbing a rope

For example, suppose that an open-end mutual fund calculates its net asset value at 4:00 p.m. eastern standard time (EST), as is common for most of these funds. If an investor purchase shares in that fund before the 4:00 p.m. EST pricing time, the investor will receive that day’s net asset value price for the stock. If the investor buys fund shares after the 4:00 p.m. EST pricing time, however, the investor will receive the next day’s net value price for the shares.

In some markets, investment companies are required to use forward prices by law. For example, in the United States, the Securities and Exchange Commission (SEC) requires investment companies, underwriters and dealers to use forward pricing arrangements when buying or selling shares in an open-end mutual fund. Failure to use a forward price contract can result in significant civil and criminal penalties for a fund.

Late trading is the practice of allowing investors to receive the prior day’s share price after a fund’s pricing time passes. This practice is illegal in some countries. For example, suppose that a favored buyer places an order after a fund's 4:00 p.m. EST pricing time. If the investment fund manager gives the buyer the share price calculated before 4:00 p.m. EST, he or she is engaging in late trading. Late trading can give late traders the opportunity to capitalize on events that occur after the pricing time at the expense of long-term fund investors. Engaging in late trading is often viewed as a breach of a fund manager’s fiduciary obligations to the fund and its shareholders.

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