Contrast futures with forwards on cash flows and counterparty credit risk
The idea
A forward settles once, at expiry, so the whole gain or loss accumulates as an unrealised claim on a single counterparty. A future is marked to market daily through an exchange: the same economic exposure is delivered, but the profit or loss is settled in cash every day and credit exposure never accumulates beyond one day's move. The daily settlement changes the timing of cash flows, which matters when interest rates are correlated with the underlying, and it forces a margin account that must be topped up on demand.
A practice question
What is the principal operational difference between a forward and a future?
- A forward has no expiry dateWhy not: Every forward has an agreed settlement date; that is what makes it a forward.
- A future is settled daily — correct
- A future cannot be used to hedgeWhy not: Hedging is the original purpose of futures markets.
A forward settles once at expiry. Daily mark-to-market is the defining feature of a futures contract: it delivers the same exposure as a forward but releases the gain or loss as cash each day.
A harder one
Why does a futures position carry less counterparty credit exposure than an otherwise identical forward?
- Because futures are always fully collateralised in advanceWhy not: Initial margin is a fraction of the notional, not full collateral. What limits exposure is settling each day.
- Because futures contracts are legally unenforceableWhy not: They are fully enforceable, and the clearing house stands behind them.
- Because gains are settled daily, so exposure never accumulates beyond one day's move — correct
A forward's unrealised gain builds up over the whole life of the contract and is owed by one counterparty. Daily settlement resets the exposure, and the clearing house stands between the parties.
The hardest tier
When does daily settlement make a future genuinely worth more or less than a forward?
- When the underlying is a commodityWhy not: Storage and convenience yield affect the price level, not the wedge between forward and futures pricing.
- When interest rates are correlated with the underlying — correct
- When the contract runs for longer than a yearWhy not: Maturity lengthens the effect but does not create it; correlation with rates is what does.
Absent that correlation the timing difference washes out; with it, it does not.
In the app: 9 practice questions on this outcome, a narrated walkthrough with diagrams, spaced review that brings it back before you forget it.
Take the free diagnostic →