Difference between forward and futures prices

The pricing of the futures contracts is also similar to the pricing of the forward contracts. The only difference is that the futures contracts are marked-to-market daily and if the position is in profit then that amount will be added to the margin account.

Value of futures contract: The value of futures contract differ than the forward prices because they are marked-to-market daily and at the end of each trading days, the value of the futures contract become zero. The value during the trading day is equal to the futures price minus the futures price at the last settlement date.

If interest rates are positively correlated with the futures prices, then the margin money can be reinvested at a higher interest rate and thus futures are more desirable than forwards and tend to have slightly higher prices.

If interest rates are negatively correlated with the futures prices, then the margin money will be reinvested at a lower interest rate, and thus futures are less desirable than futures and tend to have slightly lower prices.

If interest rates are uncorrelated with the futures prices, then the futures prices and forward prices will be the same.

Check your concepts:

(58.11) The forward price of an asset is higher than its futures price. What will be the most likely payoff of a short position in the forward contract if there has been an increase in the interest rate after the initiation of the position?

(a) Positive payoff
(b) Zero payoff
(c) Negative payoff

Solutions:

(58.11) Correct Answer is A: The forward price is higher than the futures price when the correlation between the futures price and interest rate is negative. Since the interest rates have increased, the forward price is most likely to decrease. Therefore, a short position in the forward contract is most likely to have a positive payoff.

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