Futures Prices vs Forwards Prices
While many of you think this may be a repeated question, it’s slightly different.
In a past AnalystForum CFA discussion there was a question discussed which is the following:
Q. When interest rate changes are negatively correlated with the price changes of the asset underlying a futures/forward contract:
A. Forward prices are higher
B. Futures prices are higher
C. Futures prices may be higher or lower depending on the risk-free rate and price volatility.
The answer was A, and this question was once discussed here and there were good explanations of why futures prices would be higher than forward prices if the correlation was positive ( https://www.analystforum.com/forums/cfa-forums/cfa-level-ii-forum/91329896)
But here’s what I don’t understand:
when there is a positive correlation btw interest rates and spot prices then you would have excess margin and higher interest to invest in. So no doubt people would prefer futures which causes its price to rise. No problem with this.
However, when the correlation is negative like the question above, I don’t understand why people would switch to preferring forwards. Yes the interest may get lower while the spot price goes up, but you still receive excess margin compared to choosing a forward. I mean, you can just keep your excess margin until the interest rate becomes higher later, right? It still doesn’t change the fact that you make more money (excess margin) when having a future compared to having a forward because of the daily settlement. So shouldn’t you still be preferring futures to forwards even when the correlation is negative??
This has been confusing me for a while so I would be grateful to anyone who can provide me with a clear answer on exactly what I’m overlooking.
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