Explanation

For interest rate derivatives like FRAs and Eurodollar futures, the forward rate is typically higher than the futures rate due to convexity adjustment. This occurs because:

1. Mark-to-market settlement: Futures contracts are marked to market daily, creating cash flow timing differences
2. Correlation between rates and margin flows: When interest rates rise, futures prices fall, and the short position receives margin payments that can be reinvested at higher rates
3. Convexity effect: This systematic advantage for the short position means futures rates must be lower than forward rates to compensate

The relationship is given by: $\text{Forward Rate} = \text{Futures Rate} + \frac{1}{2}\sigma^2 T_1 T_2$

Where:

• $\sigma$ = volatility of short-term interest rate
• $T_1$ = time to maturity of the contract
• $T_2$ = time to maturity of the underlying rate

Therefore, the forward rate is normally higher than the futures rate.