[ 2009 FRM Sample Exam ] Market risk measurement and management Q23 management, statements, describes, following, maintain

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23. Which of the following statements correctly describes the relationship between the forward price and the futures price on the same underlying asset with the same maturity date (ignore taxes, transaction costs and credit risk)?

A. The futures price is always lower than the forward price, because the investor needs to maintain margin in the case of futures contracts.

B. When the asset price is positively correlated with interest rate, the futures price tends to be higher than the forward price.

C. The futures price and forward price are always the same, because if they are different, arbitrageurs can lock in a riskless profit by entering offsetting transactions in the two markets.

D. In the case of interest rate contracts, forward rate can be obtained from Eurodollar futures rate by using convexity adjustment. The amount of adjustment is proportional to the volatility of the rate and inversely proportional to the time to maturity of the contract.

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Correct answer is Bfficeffice" />

The primary difference between forward and futures is the daily mark?to?market and settlement in the futures contract.  As explained in Chapter 3 of John Hull book, if an asset is positively correlated with interest rate, futures price tends to be higher than the forward price.

Answer a) is incorrect since margin account does not automatically lead to a lower futures price.

Answer c) is incorrect since forward price and futures price do differ.

Answer d) is incorrect since the convexity adjustment is proportional to the maturity of the contract.

ffice:smarttags" />Reading: John Hull, Chapters 3 and 5