Updated for the 2026-2027 CFA® Level I curriculum.
Forward and futures prices come from the same no-arbitrage logic, but they are not always identical. The gap comes from one mechanical difference: futures settle daily, forwards do not. This note explains why that difference matters and how interest-rate correlation determines which price ends up higher. After reviewing this note, you should be able to state the direction of the forward-futures price gap given a correlation assumption, without memorizing it as an isolated rule.
Quick Answer
Forward and futures prices differ because futures require daily settlement while forwards settle only at expiration. Futures gains and losses are reinvested or financed at whatever interest rate prevails on that day, an amount that is uncertain in advance. If the underlying price and interest rates move together, futures prices run higher than forward prices. If they move in opposite directions, futures prices run lower. With little or no correlation, the two prices are approximately equal.
Key Takeaways About Why Forward and Futures Prices Differ
Forward and futures prices differ only because of daily settlement, not because they use different pricing models.
Futures use daily mark-to-market. Forwards settle once, at expiration.
Futures gains and losses must be reinvested or financed at the short-term rate prevailing on the day they occur.
Positive correlation between the underlying price and interest rates pushes the futures price above the forward price.
Negative correlation pushes the futures price below the forward price.
Zero or weak correlation makes the two prices approximately equal.
Short maturities and low rate volatility make the price gap small enough to ignore for most exam problems.
What You Need to Know for CFA Level I
Explain that daily settlement, not a separate pricing model, causes forward and futures prices to diverge.
Identify the direction of the price difference given a stated correlation between interest rates and the underlying asset.
Recognize when the difference is negligible: short maturity, low rate volatility, or no meaningful correlation.
Distinguish reinvestment risk in futures from the absence of interim cash flow in forwards.
Apply the correlation-based reasoning without needing to calculate the exact size of the price gap.
Why Forward and Futures Prices Are Often Similar
Under certainty, forward and futures prices are the same. Both contracts require no upfront payment, and both are priced using the same cost-of-carry relationship: compound the spot price at the risk-free rate, adjusted for any carry costs or benefits. That baseline calculation does not care whether the contract is a forward or a futures.
The divergence comes from what happens after initiation, not from how the initial price is set. Specifically, it depends on whether cash changes hands before expiration and how that cash is reinvested or financed.
Daily Settlement and Reinvestment
Futures contracts settle daily. Gains are credited to the margin account and losses are debited, every trading day, for the life of the contract. That creates reinvestment risk. A gain earned today does not sit still. It gets reinvested at whatever short-term rate is available that day, not at a rate locked in when the contract was initiated.
A forward contract has no interim cash flow. The full gain or loss is realized only at expiration. There is nothing to reinvest along the way.
This means the futures price depends on the path of interest rates over the life of the contract, not just the rate at initiation. The forward price does not carry that same path dependency.
Role of Interest-Rate Correlation
The direction of the price gap depends on how the underlying asset's price correlates with interest rates.
If the underlying price rises when rates are also high, the futures long receives cash gains at a time when reinvestment rates are attractive. That reinvestment income is something the forward holder never receives, since the forward holder has no interim cash flow to reinvest. To keep both contracts fairly priced at initiation, the futures price must start out higher than the forward price. Otherwise, being long futures would offer a built-in advantage with no offsetting cost.
If the underlying price falls when rates are high, the futures long faces cash losses precisely when financing those losses is expensive. That is a disadvantage relative to the forward holder, who defers the loss without financing it along the way. To offset this disadvantage, the futures price starts out lower than the forward price.
When Futures Prices Can Be Higher or Lower
Correlation Type | Cash-Flow Logic | Price Relationship |
|---|---|---|
Positive (underlying price and interest rates move together) | Futures gains arrive when rates are high, so reinvestment income is favorable for the long | Futures price > Forward price |
Negative (underlying price and interest rates move oppositely) | Futures losses arrive when rates are high, making financing more costly for the long | Futures price < Forward price |
Zero or weak correlation | Reinvestment timing has no systematic advantage or disadvantage | Futures price ≈ Forward price |
When the Prices Are Approximately Equal
The price gap shrinks toward zero when any of these hold:
The contract has a short maturity, leaving little time for reinvestment effects to accumulate.
Interest rates show low volatility over the contract's life.
The underlying price has little or no correlation with interest rates.
For most CFA Level I problems, unless a question explicitly states a correlation assumption, treat forward and futures prices as equal.
Worked Example
A company enters a three-year interest rate swap with a $10 million notional. The company pays a fixed rate of 4.00% annually and receives a floating rate set at the start of each year, based on a market reference rate. Settlement happens once per year, net.
Assume the floating rate resets are 3.50% for year 1, 4.20% for year 2, and 4.60% for year 3.
Year 1 settlement
Fixed rate (4.00%) exceeds floating rate (3.50%). The fixed-rate payer owes the difference:
The $50,000 is paid by the fixed-rate payer.
Year 2 settlement
Floating rate (4.20%) exceeds fixed rate (4.00%). The fixed-rate receiver owes the difference:
The $20,000 is paid by the fixed-rate receiver.
Year 3 settlement
Floating rate (4.60%) exceeds fixed rate (4.00%). The net settlement is:
The $60,000 is paid by the fixed-rate receiver.
Each year settles like an individual forward, comparing a locked-in rate to a rate observed just for that period. But the 4.00% fixed rate never changes, it was set once for all three years.
A true series of independently negotiated forwards would likely use three different forward rates, one reflecting the market's expectation for each specific year, not one flat rate repeated three times.
Common Exam Traps
Treating each swap payment as a separately negotiated forward. The fixed rate is fixed for the entire swap term. It is not reset or renegotiated period to period the way independent forward rates would be.
Assuming principal is exchanged. A plain vanilla interest rate swap exchanges interest payments calculated on a notional amount. The notional itself does not change hands.
Confusing fixed-rate payer with receiving fixed. The fixed-rate payer pays fixed and receives floating. Mixing this up flips the direction of every settlement calculation.
Ignoring net settlement. Candidates sometimes calculate both gross payments separately. Only the net difference actually changes hands at each settlement date.
Practice Questions
An interest rate swap has a $5 million notional, a fixed rate of 3.80%, and annual net settlement. In year 2, the floating rate resets at 4.10%. Which statement is most accurate?
The fixed-rate payer owes $15,000 to the fixed-rate receiver.
The fixed-rate receiver owes $15,000 to the fixed-rate payer.
Both parties exchange gross payments of $190,000 and $205,000.
Correct Answer: B
The floating rate (4.10%) exceeds the fixed rate (3.80%) by 0.30%. On a $5,000,000 notional:
The fixed-rate payer receives floating and pays fixed, so when floating exceeds fixed, the fixed-rate payer is owed money and the fixed-rate receiver pays it. Since the receiver owes the payer, the correct direction is: the fixed-rate receiver pays $15,000 to the fixed-rate payer.
Option A: Reverses the direction of net settlement. The fixed-rate payer receives the higher floating payment, so the payer is owed the difference.
Option C: Incorrectly assumes gross settlement instead of net settlement, ignoring how swaps actually clear at each date.
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FAQs About Swaps as a Series of Forward Contracts
Is a swap just a bundle of forward contracts?
Not exactly. Each settlement period behaves like a forward payoff, but the swap uses one fixed rate across all periods and settles as a single contract, not a group of separately priced agreements.
Does principal change hands in an interest rate swap?
No. A plain vanilla interest rate swap exchanges interest payments calculated on a notional amount. The notional principal itself is never exchanged.
Why does the swap use one fixed rate instead of a different rate for each period?
The fixed rate is set once, at initiation, so that the combined value of the implied forward-like cash flows equals zero across the whole swap. This is different from pricing each period as its own zero-value forward.