can someone please explain why investors choose long futures over forwards when asset prices are positively correlated with interest rates? and long forwards with negative correlation?
When correlation is positive, the higher asset returns go hand in hand with higher interest rates, that means you get a higher return on re-investment because of the mark-to-market characteristic of futures. When Again, when correlation is positive, and asset returns go down, the interest rates go down as well and the funding of those losses are cheaper. Investors are smart, they understand this, and will boost demand for futures, so future prices go up.
If correlation is negative, it’s the otherway around. Futures are less in demand, their prices fall.
Just remember the fact that futures contracts have the mark-to-market aspect.
For the below explantion, presume that the asset has positive correlation with interest rates.
/// FUTURES CONTRACT ///
When the asset does well, the contract is marked-to market and the long holder of the asset now has a cash influx. Because of the positive correlation with interest rates, the interest rates should have also increased. Therefore, this excess cash influx can now be used for better investment opportunities (b/c of higher interest rates).
When the asset does poorly, the contract is marked-to-market and the long holder of the asset now has to put up more cash. Becasue of the positive correlation, interest rates have decreased as well in all liklihood. Therefore, the long holder can borrow at lower rates to get the cash for the mark-to-market.
/// FORWARD CONTRACT ///
A long forward with positive interest rate correlation will have none of the aforementioned benefits.
If you understood why it makes sense to desire a long futures for an asset with positive interest correlation from my explanation above, you can just back into any other scenario (e.g., a futures contract is not desirable with negative interest rate correlation b/c when the asset value decreases, there is a mark-to-market, and the interest rates (thus, borrowing costs) will be higher).
Hope that helped a little
thanks guys much appreciated