The big difference between forwards contracts and futures contracts is in how they are
settled. Suppose you are long a forward contract on oil, that is you are obligated to
buy a certain amount of oil for a certain price on a certain future date. As the price
of oil changes so to does the value of the contract. Each day you check the price of
oil and mentally calculate whether the value of your contract has gone up or down,
however you never receive or pay money until the expiry date of the forward. When you
enter into a futures contract however, you have to settle up your position every single
day until the expiry of the contract (and sometimes even more frequently, depending
on what commodity exchange you're trading with). If oil goes up by $1 today then
you get $1 at the end of the day; then if tomorrow it goes down by $2 you have to
pay $2 at the end of the day. It seems like a minor di erence, but it's done to make
sure that if someone isn't able to live up to the obligations of their contract they are
caught early on and not when the contract expires. This subtle di erence can a ect
the delivery price of a contract; in general the delivery prices for forwards and futures
are not the same. The main reason for this is that interest rates change over time. The
money that changes hands at the end of each day can be reinvested by the party that
is receiving the money (even if only for a day), and as the interest rate changes it can
be more advantageous to hold a futures contract rather than a forwards contract.
If interest rates are constant there is a nice arbitrage argument, which we will discuss
in class, that shows that the delivery price for a forwards should be the same as the
delivery price for a futures. Now here's the question: suppose that interest rates are
not constant between now and the maturity date, however it is known that they will
only rise between now and then. Which contract should have a higher delivery price,
the forwards or the futures?
This is the exercise at the end of the chapter
i do not know the answer
could anyone explain it?
Thanks in advance
settled. Suppose you are long a forward contract on oil, that is you are obligated to
buy a certain amount of oil for a certain price on a certain future date. As the price
of oil changes so to does the value of the contract. Each day you check the price of
oil and mentally calculate whether the value of your contract has gone up or down,
however you never receive or pay money until the expiry date of the forward. When you
enter into a futures contract however, you have to settle up your position every single
day until the expiry of the contract (and sometimes even more frequently, depending
on what commodity exchange you're trading with). If oil goes up by $1 today then
you get $1 at the end of the day; then if tomorrow it goes down by $2 you have to
pay $2 at the end of the day. It seems like a minor di erence, but it's done to make
sure that if someone isn't able to live up to the obligations of their contract they are
caught early on and not when the contract expires. This subtle di erence can a ect
the delivery price of a contract; in general the delivery prices for forwards and futures
are not the same. The main reason for this is that interest rates change over time. The
money that changes hands at the end of each day can be reinvested by the party that
is receiving the money (even if only for a day), and as the interest rate changes it can
be more advantageous to hold a futures contract rather than a forwards contract.
If interest rates are constant there is a nice arbitrage argument, which we will discuss
in class, that shows that the delivery price for a forwards should be the same as the
delivery price for a futures. Now here's the question: suppose that interest rates are
not constant between now and the maturity date, however it is known that they will
only rise between now and then. Which contract should have a higher delivery price,
the forwards or the futures?
This is the exercise at the end of the chapter
i do not know the answer
could anyone explain it?
Thanks in advance