Futures vs Forwards - Different prices

[Ajp11]

A question from the circulum, mentions that they will differ if the Futures Price and Intrest Rate are negatively correlated. Please can someone explain why this is the case for me?
Thank you!

 

[tau281290]

I think you are referring to this?
Future prices will be higher than foward prices when interest rates and future prices are positively correlated because futures gains/losses are settled each day, excess margin provides funds, earning more interests when rates are high.
Future prices are lower than forward prices when rates and future prices are negatively correlated because you require funds when rates are low.

 

[S2000magician]

Because gains/losses are settled each day, your margin account will increase with gains and decrease with losses. Because your margin account earns interest, you’ll earn more interest when rates increase, and less interest when rates decrease.
As the long position, if there is a positive correlation between the price of the underlying and interest rates, when the underlying increases in price your margin account increases and you’ll earn higher interest on that money, a favorable outcome; when the underlying decreases in price your margin account decreases, but you’ll lose less interest (rates go down), a (relatively) favorable outcome. As both outcomes are in your favor, you’d be willing to pay a higher price on the future than on a forward that doesn’t have a margin account and receives no benefit from changing interest rates.
If there is a negative correlation between the price of the underlying and interest rates, you earn less interest when your margin account increases, and lose more interest when it decreases, both unfavorable outcomes; you’ll pay a lower price for the futures.

 

[Monad]

What does it mean to short Forward (1,1)? And how it does work practically?

 

[S2000magician]

Monad wrote: What does it mean to short Forward (1,1)? And how it does work practically?

It means that you have entered into the short position in the forward contract: you agree to deliver the underlying at a specific time at the agreed price.
Practically, it means that you have effectively sold the underlying: you will gain if the price of the underlying decreases between the day you enter into the forward contract and the day it expires (and you have to deliver the underlying), and you will lose if the price of the underlying increases.

 

[Monad]

S2000magician wrote:

Monad wrote: What does it mean to short Forward (1,1)? And how it does work practically?

It means that you have entered into the short position in the forward contract: you agree to deliver the underlying at a specific time at the agreed price.
Practically, it means that you have effectively sold the underlying: you will gain if the price of the underlying decreases between the day you enter into the forward contract and the day it expires (and you have to deliver the underlying), and you will lose if the price of the underlying increases.

Thank you… S2000magician..for simple explanation….

 

[Sufy]

Monad wrote:
What does it mean to short Forward (1,1)? And how it does work practically?

By (1,1) I think you are referring to an interest rate forward. Sine you are short, you agree to lend at a fixed rate deided today one month from now for a period of 1 month.

 

[Sufy]

And yes, if rates derease, you actually get to earn a higher interest rate on the amount you lent. Which syncs with theory that shortis in the money when rates decrease.

 

[S2000magician]

Monad wrote:

S2000magician wrote:

Monad wrote: What does it mean to short Forward (1,1)? And how it does work practically?

It means that you have entered into the short position in the forward contract: you agree to deliver the underlying at a specific time at the agreed price.
Practically, it means that you have effectively sold the underlying: you will gain if the price of the underlying decreases between the day you enter into the forward contract and the day it expires (and you have to deliver the underlying), and you will lose if the price of the underlying increases.

Thank you… S2000magician..for simple explanation….

My pleasure.