Recall that in Forwards, the price of Fwd is decided today and then any cash exchange will occur only at the end of the forward period. So, value of forward is non-zero during the life of the Forward.
However, for Futures, since the Clearing House takes some margin, it does M2M daily at the end of the day. This is to ensure that no party gets too delinquent and the default risk is minimized. Thus, say there is a futures contract set at price = 100. Say, the initial margin = 75%($75) and the maintenance margin is 25%($25). Now, say today, the price of the futures rises to 120. So, the long is in profit of $20. Long’s margin increases by 20 to become $95.
He can take this excess money and invest it somewhere else if he wishes to do so. If at such a time, the interest rates in the markets are high, the person is in a double benefit (he got a profit and he’s able to invest at higher price) – in such a case, the Future contract will be costlier compared to a forward contract because you have the interest rate advantage as well.
Hence, to generalize, when interest rates are positively correlated with the spot price, the Futures will be more valuable than forwards (because of reinvestment income) and similarly, if the interest rate is negatively correlated, this would mean that when future price is decreasing, we are in a loss and interest rates are high. So, we will have to borrow money at higher rate and pay the margin which is undesirable, driving down Futures price as compared to Forward price (in forward, no cash would have to be given.)
Fut and Fwd rates are same when interest rate is fixed or when interest rate is uncorrelated to the underlying price.
Answer will be option C here.
Recall that in Forwards, the price of Fwd is decided today and then any cash exchange will occur only at the end of the forward period. So, value of forward is non-zero during the life of the Forward.
However, for Futures, since the Clearing House takes some margin, it does M2M daily at the end of the day. This is to ensure that no party gets too delinquent and the default risk is minimized. Thus, say there is a futures contract set at price = 100. Say, the initial margin = 75%($75) and the maintenance margin is 25%($25). Now, say today, the price of the futures rises to 120. So, the long is in profit of $20. Long’s margin increases by 20 to become $95.
He can take this excess money and invest it somewhere else if he wishes to do so. If at such a time, the interest rates in the markets are high, the person is in a double benefit (he got a profit and he’s able to invest at higher price) – in such a case, the Future contract will be costlier compared to a forward contract because you have the interest rate advantage as well.
Hence, to generalize, when interest rates are positively correlated with the spot price, the Futures will be more valuable than forwards (because of reinvestment income) and similarly, if the interest rate is negatively correlated, this would mean that when future price is decreasing, we are in a loss and interest rates are high. So, we will have to borrow money at higher rate and pay the margin which is undesirable, driving down Futures price as compared to Forward price (in forward, no cash would have to be given.)
Fut and Fwd rates are same when interest rate is fixed or when interest rate is uncorrelated to the underlying price.