Answer: futures prices and interest rates are uncorrelated.

## Explanation Forward and futures prices differ primarily due to the **marking-to-market** feature of futures contracts. The key difference arises from the correlation between futures prices and interest rates. ### Key Concepts: 1. **Forward contracts** are settled only at expiration (no daily settlements) 2. **Futures contracts** are marked-to-market daily (daily settlements) 3. **Daily settlements** create cash flows that can be reinvested or require financing ### Why Correlation Matters: - When futures prices and interest rates are **positively correlated**: - Rising futures prices → Long position receives cash → Can invest at higher interest rates - Falling futures prices → Long position pays cash → Can borrow at lower interest rates - This creates an advantage for futures over forwards → Futures price > Forward price - When futures prices and interest rates are **negatively correlated**: - Rising futures prices → Long position receives cash → Must invest at lower interest rates - Falling futures prices → Long position pays cash → Must borrow at higher interest rates - This creates a disadvantage for futures → Futures price < Forward price - When futures prices and interest rates are **uncorrelated**: - No systematic advantage or disadvantage from daily settlements - Expected value of reinvestment/financing effects is zero - **Forward price = Futures price** ### Mathematical Basis: The relationship can be expressed as: Futures Price = Forward Price × e^(covariance term) Where the covariance term depends on the correlation between futures price changes and interest rate changes. When correlation = 0, the covariance term = 0, making futures price = forward price. ### Practical Implications: - For most assets, the correlation is small enough that forward and futures prices are approximately equal - For interest rate futures, the correlation is significant and must be considered - The difference is more pronounced for longer-dated contracts Therefore, forward and futures prices are equal when futures prices and interest rates are uncorrelated, making option **B** correct.

Author: LeetQuiz .