Got a question on the logic of this problem. Part of Givens in the Problem (rest of the info given is irrelevant to the question) 1) Mazakhastan’s investors use mark-to-market valuation system. 2) S&P just raised Mazakhastan’s sovereign debt to investment grade. 3) Interest rates tend to move in the same direction as asset values 4) New tech innovations and commerical expansion has substantially boosted the income of the avg Mazakhastanian. QUESTION: Based on the info above, Mason can best conclude that a) futures prices are higher than forward prices in Mazakhastan b) inflation in Mazakhastan is likely to rise c) prices of corp bond in Mazakhastan are likely to rise. Answer: A. Since Mazakhastanian investors prefer mark-to-market accounting and interest rates are positively correlated to asset values, Mason can conclude that futures prices are higher than forward prices. Can anyone explain to logic to this answer? Thanks
futures differ from forwards in that there is a mark-to-market cash flow each day. Because of the positive correlation to asset prices , investors see positive cash flow in their margin accounts , which they can invest profitably elsewhere . So Futures attract a premium over forwards , where cash flow takes place only at expiry
since interest rates move in the same direction as the asset values, investors will prefer the mark to market which happens in a futures contract. hence futures will be costlier than forwards.
aahhh~~~ thats right… the positive correlation of asset price and interest rate changes… thanks!
Would the ‘customization value’ of a Forward (vs. a Future) ever overcompensate in the pricing when you have positive correlation between the asset price and interest rates? I’m just curious to know if there is a better way to quantify this.
investors prefer futures over forwards as they can realize gains earlier than those for forwards and reinvest these gains before maturity ( like European option?). Similarly when int rates fall, they can borrow cheap and invest in equity mkts as equity is doing good
so more demand for futures during equity/int rates +vely correlated times makes futures pricier than forwards.
Thanks for the question
Hmm. Theoretically, you could get the mark-to-market on a forward contract, and then borrow money whenever you have a paper gain. This would allow you to synthetically “realize gains earlier”, similar to how you would do it with a futures position. This is probably too much work for most people though.
Ohai…that is the difference though right?
Forward and Futures are similar in the sense that they are both Contract prices however Futures, contrary to Forwards, is exchange regulated so the gains are posted to your account on a regular basis…