Question

Using your own words, briefly (1 paragraph max) explain why:

a. An investor may prefer a forward contract to a futures contract.

b. An investor may prefer a futures contract to a forward contract.

Answer 1

1.
When the terms of the contract (delivery, settlement mechanism, quantity etc.) need to be customized and are not the same as the ones regularly traded on exchange, forwards are preferred. When there is very less counterparty default risk, it is better to use forwards versus futures and thus pay lower price. When one does not have sufficient liquidity before the maturity to fulfill margin maintenance requirements. When there is not much liquidity required and contract is expected to be held till expiry, prefer forwards versus futures. When one is expecting negative correlation between rates and asset it is better to have forwards in case of long position and when one is expecting positive correlation between rates and asset it is better to have forwards in case of short position.

2.
When the contract might be sold before the expiry futures might be preferred as they are more liquid. When there is high counterparty risk futures might be preferred. When one is expecting positive correlation between rates and asset it is better to have futures in case of long position and when one is expecting negative correlation between rates and asset it is better to have futures in case of short position. When the terms of the contract (delivery, settlement mechanism, quantity etc.) need not be customized and are not the same as the ones regularly traded on exchange, futures are preferred.