What are the assumptions that allow us to obtain the prices of futures and forward contracts...

What are the assumptions that allow us to obtain the prices of futures and forward contracts in the same way? What happens if these assumptions are not satisfied?

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Expert Solution

The prices of futures and forward contracts are defined in the same way. Due to the marking-to-market feature of futures, there is no specific reason to state that futures prices will be equal to forward prices. Marking To Market is the process of valuing assets according to market prices at the end of each day and is arrived at the profit or loss status in a futures transaction

The following are the assumptions to obtain the prices of futures and forward contracts in the same way

If interest rates are deterministic then futures and forward prices will be equal. This result is obtained only because the number of futures contracts to sell for every forward purchased can be established.
If futures prices are uncorrelated with interest rates, then futures prices will be equal to forward prices. If futures prices are positively correlated with interest rates, the futures prices will be more than forward prices. And, If futures prices are negatively correlated with interest rates, the futures prices will be lesser than forward prices.

If these assumptions are not satisfied that is if the interest rate is uncertain, the prices of futures may differ from that of forward contracts. And when there is positive or negative correlation between the interest rates and the futures prices, the prices of futures will be different from that of forward contracts.

jeff jeffy answered 1 year ago

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