are futures and forwards the same ????

Would futures and forward result in the same outcome? I read somewhere that it can be proven mathematically that they do, but I am unable to see it.

For example if the Spot is 100 and rf is 10%, a futures or forward contract expiring in a year would be priced at 110.

If at expiry the spot is 110, the trader who is long a forward will gain nothing.

Now had he used a future instead…

Say that one day into the contract the future price somehow moved to 120, the futures will be marked to market at the long trader would get 10 added to his margin account.

Assume due to price changes and interest rate changes the futures price managed to stay at 120 all year. So there was no other mark to market. However on the last day the futures price moved back to 110. The trader would close out his position by paying 10.

So he got 10 on day one, and paid it back on the last day, essentially gaining the interest of 0.1.

However the trader who entered a forward got nothing.

Can someone please help?

I found the place where I read that they can be shown to be the same. CFA Level II curriculum page 90. "if interest rates are constant or at least know…the effect of marking to market can be show neutral. I tried it in excel while keeping interest rates constant at 10%. I tried it in excel with a simple example keeping interest at a constant. t Spot Future price Mark to market Future value of mark to market 0.00 $100.00 $259.37 1.00 $100.00 $235.79 -$23.58 -$55.60 2.00 $100.00 $214.36 -$21.44 -$45.95 3.00 $100.00 $194.87 -$19.49 -$37.97 4.00 $100.00 $177.16 -$17.72 -$31.38 5.00 $100.00 $161.05 -$16.11 -$25.94 6.00 $100.00 $146.41 -$14.64 -$21.44 7.00 $100.00 $133.10 -$13.31 -$17.72 8.00 $100.00 $121.00 -$12.10 -$14.64 9.00 $100.00 $110.00 -$11.00 -$12.10 10.00 $100.00 $100.00 -$10.00 -$10.00 -$159.37 -$272.74 the future value of payments by long future trader are 272, while a trader who was long the forward would simply pay 159 at expiration?>

…well I’m not sure how to answer your question. Far as I know futures are standardized, trade on exchanges and are M2M daily accordingly. They can be seen as a series of forwards, if I am not mistaken. That’s about as much as I can do for you right now…

Your question is very confusing. It is not the same because the convention and the way they are traded is very different. However, you prove that they are the same because of the payout? Maybe your question should really be do they offer the same payout; a forward contract and futures contract will offer the same payout if the underlying conventions are the same; deliveries, trade settlement type, etc, etc. You just have to realize that if a forward and future contract with the same underlying factors offer a different payout, then there will be an arbitrage opportunity.

Okay for anyone interested in helping please take a look at this excel sheet (expires in 5 days). The sheet compares the outcome of the futures and forward contract. Under the simplistic conditions of the sheet, fixed R and fixed S, we can see that the total payoff from the contracts is the same. However the futures contract made that payoff at an earlier time (spread out). Adjusting for teh interest makes the contracts not equivilant at all… Am I missing somthing?

the adjusted credit risk … when the futures does the mark to market it is ensuring that the credit risk on the contract is minimal. but with the forward contract - the “gainer” in the transaction faces the full credit risk, that either the payment will not be made, or the “underlying” will not be delivered. maybe that makes the two identical. additionally, I do remember (not read the portion this year yet), I think there is a point at which forwards are better, and some place where futures are better. Need to get that here… maybe that is the differentiater.

You are comparing apples to oranges. Once there is a difference in the term of the contracts between the futures and the forward it will make the payout different. Marking to Market on the futures contract minimizes credit risk which in your case the forward contract is not doing. You can set up a forward contract that also mark to market; who ever said a forward contract doesn’t do that. You are just assuming that a forward contract only pays out in the end which is not true as all forward contracts are OTC which can be customized. Additionally, you can also think of it this way. On the futures contract, you mark to market and invest the gain on a risk free return. If your forward contract has a positive value, you can borrow against it and also invest it at some risk free rate. Or even close out part of the forward contract, which effective is similar to marking to market. Basically you are just assuming certain conditions on the forward contract which you shouldn’t be

Liquidity risk , settlement risk , legal risk etc figure more prominently in forwards

Fundamentally futures and forwards are same for hedging purpose. Forward - Credit risk = Future. Technically, how do you remove credit risk from forward? Clearing house acts as a middle man by marking to market daily with margin accounts. You need some initial deposit in margin to trade in futures. You earn a nominal interest returns on margin account balance. If you ignore interest rate the payoffs are equal. However, the major factor affecting futures and forwards price movements is interest rates. Some other interesting points from my L2 notes: Forwards are more valid for exchange for physical transactions. At the end of the term long pays and receives the underlying. Futures are more for betting on underlying price direction. At the end of the term no one needs to pay and exchange underlying, margin accounts will be marked to market and the contract is closed by the clearing house. Futures represent leverage. Consider a share of IBM as underlying and one year forward selling for $110 and you expect the value to go up to $120 in a year. You can buy a one year forward and invest $100 today in interest earning account at 10% per annum and pay at the end of the year $110 and take delivery of IBM share. If share price at the end is $90 you lose $10 and if share price is $120 you gain $20. However, you may be able to buy a future for 10 IBM shares with just a $100 margin deposit and at the end if share price is $90 your margin account goes to 0 and if share price is $120 you gain $200. This is leverage effect. Remember, if your margin account goes to 0 before end of the year you will have to add money into margin to keep the position, otherwise your position will be liquidated by clearing house. If the interest rates are positively correlated with the underlying asset or futures prices, traders will prefer futures over forwards, because when interest increase the underlying values increase, the margin balances increase and interest earnings will increase. Also when interest rates decrease the underlying values decrease, the margin balances decrease and long can borrow at lower costs to cover losses. Traders holding long positions prefer the marking to market feature of futures when underlying asset price, consequently futures price, is positively correlated with interest rates. And eventually futures prices of such assets are higher than forward prices. Conversely, when prices are negatively correlated to interest rates, traders will prefer not to mark to market, so forward contracts will carry higher prices. Gold futures prices and interest rates would tend to be positively correlated and investors tend to prefer futures. Conversely, interest rates and fixed-income security prices move in opposite directions, interest rate futures are good example of cases in which forwards are preferred.