Explanation

When there is a positive correlation between futures prices and interest rates, the price of a futures contract will be higher than the price of a forward contract on the same asset with the same expiration date for an investor with a long position.

Key Concepts:

1. Marking to Market: Futures contracts are marked to market daily, while forward contracts settle only at expiration.

2. Correlation Effect: When futures prices and interest rates are positively correlated:

   • When futures prices rise (favorable for long position), interest rates also rise
   • The long position receives daily gains that can be reinvested at higher interest rates
   • When futures prices fall (unfavorable for long position), interest rates also fall
   • The long position pays daily losses that can be financed at lower interest rates

3. Net Benefit: This creates a net benefit for the long futures position compared to a forward position, making futures more valuable.

4. Pricing Relationship: Due to this advantage, futures prices will be higher than forward prices when there is positive correlation between futures prices and interest rates.

Mathematical Basis:

The futures price (F) and forward price (F*) relationship can be expressed as: F > F* when correlation(futures price, interest rates) > 0 F = F* when correlation(futures price, interest rates) = 0 F < F* when correlation(futures price, interest rates) < 0

This is because the daily settlement feature of futures creates an advantage when price movements and interest rate movements are positively correlated.