Stock market index, the Nefer Industrial Index is currently priced at 8,765 and the one-year NII future contract is currently trading at 8,920.
Comment 1: If the future price and the fwd price (assuming the same delivery date) on a given asset were equal at a point in time, then the absolute value of open futures and fwd contracts that had been established at the same prior point at the same price would be identical
Comment 1 is best described as:
A) correct
B) incorrect, because the value of of the future contract should be lower than an equivalent forward
C) incorrect, because the value of the futures contract should be higher than an equivalent forward contract
Your answer C was incorrect. The correct answer is B the value of a futures contract will usually be much lower than that of an otherwise equivalent fwd contract because of the mk-to-mkt process. The mrk-to-market process feature means that the futures price is effectively reset to give a zero value at the start of each day.
Can anyone explain this? I still swear the answer is C
is there any information regarding the the correlation of the futures contract with the interest rate in this question ? When futures prices are negatively correlated with interest rates, traders will prefer not to mark to market, so forward contracts will carry higher prices.
At any other time prior to expiration, futures and forward prices can be the same or different. If interest rates are constant or at least known, any effect of the addition or subtraction of funds from the marking-to-market process can be shown to be neutral. If interest rates are positively correlated with futures prices, traders with long positions will prefer futures over forwards, because they will generate gains when interest rates are going up, and traders can invest those gains for higher returns. Also, traders will incur losses when interest rates are going down and can borrow to cover those losses at lower rates. Because traders holding long positions prefer the marking to market of futures over forwards when futures prices are positively correlated with interest rates, futures will carry higher prices than forwards.
(Institute 87)
Institute, CFA. CFA Institute Level II 2014 Volume 6 Derivatives and Portfolio Management. John Wiley & Sons P&T, 2013-07-12. VitalBook file.
I think it has to do something with “absolute value of open futures and forward contracts that had been established at the same prior point at the same price”
If they were the same price, that must mean that there wasn’t positive correlation between I-rates and the assets…but that doesn’t mean they were negatively correlated…still lost.
The absolute value of a forward will (almost) always be greater than the value of a future because the value of the future is reset to zero every day. The value of a future changes intraday, but is reset to zero at close after mark-to-market.
Whereas a forward will accrue value, to the long or the short, throughout the contract period.
