Future & Forward Price

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Future & Forward Price

Postby swarnendupathak » Thu Sep 20, 2012 4:00 pm

Just came accross with very interesting derivation.
The difference between future & forward price is used in any derivation synonimously. But the two can be different if there exist a correration between spot price (sp) & risk free interest rate (rf).
Scenario 1: (Positive correlation between SP & Rf)
As unlike forward contract future contract attracts to deposit initial margin money for entering the contract. Suppose a Long Call option position can withdraw the excess money from his account for any positive movement in price over & above his initial margin. So when there is a positive correlation Rf will also rise & holder of a long call can invest the excess money with higher ROI, which makes Future price more than forwad price, where no margin is required to enter the contract.
Another, when the price Sp gets decreases than the K, the holder of a long CALL Option have to respond to the margin call, which he/she should borrow at increasing Rf from the market, which will also affect the future price against forward price.

Scenario 2: (Negative correlation between SP & Rf): Will be just opposite to the above.



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Re: Future & Forward Price

Postby content.pristine » Fri Sep 21, 2012 5:30 pm

Hi Swarnendu,

Just to sum up your observation:

If the correlation between the underlying asset and interest rates is positive, people would prefer going long in the futures contract (due to mark to market) and the futures price would therefore be higher than a comparable forwards contract..

The converse is true in case the correlation between the underlying asset and interest rates are negative..


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