CFA Level I Exam · Pricing and Valuation of Futures Contracts

Futures vs Forwards and Spot-Futures Relationships

Q: What is the main difference between futures and forwards?

Futures are standardized, exchange-traded, cleared and marked to market daily with margin. Forwards are customized, trade over the counter and normally settle at maturity, so each party faces credit risk.

Q: What is contango versus backwardation?

Contango is when the futures price is above the spot price. Backwardation is when the futures price is below spot. The cause is the balance of carrying costs against the benefits of holding the asset.

Q: Why does the futures price equal the spot price at expiration?

At expiration the futures contract calls for immediate delivery of the asset. If the two prices differed, traders could buy the cheaper and sell the dearer for a riskless profit, which would force prices together.

Q: How does interest rate correlation affect futures and forward prices?

With positive correlation between the underlying asset's price (and hence the futures price) and interest rates, futures prices are higher than forward prices. With negative correlation, futures prices are lower. With no correlation, they are the same.

Updated 7 October 2026 · Fact-checked

Futures are standardized, exchange-traded and marked to market daily with margin. Forwards are customized, OTC and settle at maturity, so they carry credit risk. Futures price above spot is contango; below spot is backwardation. At expiration the futures price converges to the spot price, or arbitrage is possible.

Understand Futures vs Forwards and Spot-Futures Relationships

A forward is a private agreement between two parties to buy or sell an asset at a set price on a future date. Terms are customized. Usually no cash moves at the start, and the whole gain or loss settles at maturity. Each side bears the other's credit risk.

A futures contract is similar in economics but standardized and traded on an exchange. A clearinghouse stands between buyer and seller. Each side posts initial margin. Every day the contract is marked to market: gains are added to the margin account and losses are deducted. Under the usual rule, if the balance falls below the maintenance margin, you get a margin call and must restore the account to the initial margin level. Exact rules vary by exchange and clearinghouse. This daily settlement keeps credit exposure small.

Because futures gains and losses are paid daily, they can be reinvested or must be financed at the interest rate. This creates a link to interest rates. If the underlying asset's price (and hence the futures price) is positively correlated with interest rates, a long futures holder tends to gain when rates are high (and can reinvest at high rates) and lose when rates are low (and finance at low rates). That favors the long, so the futures price is higher than the forward price. If the correlation is negative, the futures price is lower than the forward price. If rates are constant or uncorrelated with the underlying, futures and forward prices are the same (for the same terms).

Contango means the futures price is above the spot price. Backwardation means the futures price is below spot. The curriculum defines these terms by comparing the futures price with spot. The shape of the futures curve across maturities is a related but separate idea. Which one occurs depends on the cost of carry: interest and storage costs push futures up; benefits of holding the asset, such as dividends or convenience yield, push futures down.

At expiration, the futures price must equal the spot price. If futures were higher, you would sell futures, buy the asset, and deliver for a riskless profit. If lower, you would buy futures and take delivery of the asset, selling it at spot. This is convergence. Before expiration, the gap between spot and futures is the basis (spot − futures).

Key formulas to remember

Convergence at expiration: fT(T) = ST; The futures price at expiry equals the spot price. Basis is zero at expiry.
Basis: Basis = Spot price − Futures price; Positive basis implies backwardation, negative basis implies contango, using this definition.
Contango: Futures price > Spot price; Typical when carry costs (interest, storage) exceed benefits of holding the asset.
Backwardation: Futures price < Spot price; Typical when benefits of holding (convenience yield, dividends) exceed carry costs.
Futures versus forward price and rate correlation: Positive correlation: futures price > forward price; negative correlation: futures price < forward price; zero: equal; Correlation is between the underlying asset's price (and hence the futures price) and interest rates, ignoring other differences.
Daily mark-to-market gain (long): Gain = (Today's settlement price − Yesterday's settlement price) × contract size × number of contracts; Reverse the sign for a short position.

How to solve Futures vs Forwards and Spot-Futures Relationships questions

Use this method for any question comparing futures with forwards or describing the spot-futures relationship.

1Identify what is asked: a feature comparison, a margin calculation, a curve shape, or convergence.
2For feature questions, sort each trait: standardized, exchange-traded, clearinghouse, daily settlement and margin point to futures; customized, OTC, settlement at maturity and credit risk point to forwards.
3For margin questions, compute the daily change in settlement price times contract size, then update the margin balance and compare it with maintenance margin.
4If the balance is below maintenance margin, the deposit needed restores the account to initial margin, not to maintenance margin.
5For curve questions, compare futures with spot: above is contango, below is backwardation. Then link to carry costs versus benefits.
6For interest rate correlation questions, decide the sign: positive correlation means futures price is higher than forward price; negative means lower.
7For expiration questions, apply convergence: futures price equals spot price, and any gap implies arbitrage.

Quickest way: Three-way sort

When to use it: Use it for conceptual MCQs where you must pick the correct statement among three options.

Futures means daily settlement, margin, clearinghouse, standardized. Forwards means credit risk, customized, settle at the end.
Positive correlation with rates means futures is above forward. Say it as 'positive, futures higher'.
Futures above spot is contango; below spot is backwardation.
At expiry, futures equals spot, so eliminate any option implying a difference remains.
Eliminate options that swap these facts, then pick the one that remains.

Common mistakes in Futures vs Forwards and Spot-Futures Relationships

Saying forwards have daily settlement and futures settle at maturity.
Students mix up the two contracts because both are forward commitments.
Fix: Link the word 'marked to market' with futures only. Forwards usually settle once at maturity.
Restoring a margin account to maintenance margin after a margin call.
The two margin levels are easy to confuse.
Fix: A margin call requires a deposit that brings the balance back to initial margin.
Reversing the interest rate correlation result.
Students forget who benefits from daily cash flows.
Fix: Positive correlation helps the long: gains arrive when rates are high. So futures price is higher than forward price.
Treating contango as always meaning a rising market.
The word suggests prices rising over time.
Fix: Contango only describes futures above spot now. It does not predict where spot will go.
Expecting the futures price to equal spot before expiration.
Convergence is remembered without the timing condition.
Fix: Equality holds at expiration. Earlier, the basis reflects carry costs and benefits.
Applying margin gains to the wrong side of the trade.
Students forget that the short gains when price falls.
Fix: Write long and short side by side and flip the sign of the price change for the short.

Worked examples

Example 1

An investor buys 10 futures contracts at a price of 50. Each contract has a size of 100 units. Initial margin is 400 per contract and maintenance margin is 300 per contract. The settlement price on day 1 falls to 46. What total deposit is needed? Options: A) 0, B) 4,000, C) 8,000.

Show the solution

Loss per contract = (50 − 46) × 100 = 400.
Starting balance per contract = 400, so the balance is 400 − 400 = 0 per contract.
For 10 contracts: total loss = 4,000, total initial margin = 4,000, so the total balance is 0.
The balance of 0 is below the total maintenance margin of 3,000, so there is a margin call.
The deposit restores the balance to initial margin of 4,000 in total.
Total deposit = 4,000 − 0 = 4,000.

Answer: B) 4,000 in total (400 per contract), restoring the account to initial margin.

Example 2

A commodity trades at a spot price of 80, and the three-month futures price is 77. What does this indicate, and what should happen at expiration? Options: A) Contango; futures converge to spot, B) Backwardation; futures converge to spot, C) Backwardation; spot converges to 77.

Show the solution

Compare futures with spot: 77 is below 80.
Futures below spot is backwardation.
Backwardation suggests benefits of holding the commodity, such as convenience yield, exceed carry costs.
At expiration, the futures price equals the spot price, because otherwise arbitrage is possible.
Spot does not converge to a fixed futures value; the futures price converges to whatever spot is at expiry.

Answer: B) Backwardation; the futures price converges to the spot price at expiration.

Exam tips

Expect three-option conceptual items. Check each statement for a swapped feature of futures and forwards.
For correlation questions, remember 'positive, futures higher' and eliminate the other two options quickly.
Read margin problems carefully: the deposit restores initial margin, not maintenance margin.
Do not infer a price forecast from contango or backwardation; they describe the curve today.
Under time pressure, flag long calculation items and answer concept items first; there is no penalty for wrong answers, so never leave a blank.

Practice questions from Pricing and Valuation of Futures Contracts