Hi I was wondering if anyone would be able to help me with ST5 April 2012 Question 2. This question is to do with futures rate to forward rate equation, however I am struggling to get my head around the intuition of the formula. I appreciate the answer could be obtained through following the example in the CMP on page 380 but I don't quite follow the formula logic. I understand why future prices and forward prices would differ for the interest rate future/forward. Thanks in advance
Hi mgh, You mention that you are happy with why the prices of similar futures and forward contracts would differ. Your comment made me do a Google search and I thought this made interesting viewing: https://www.cmegroup.com/education/...eurodollars/understanding-convexity-bias.html With regard to the convexity adjustment, the 'intuition' behind it is the same, namely it is because of the marking to market of futures contracts which leads otherwise similar futures and forward contracts to have different payoffs. Put another way, two otherwise similar futures and forward contracts with the same (contract) price, will have different (reference) rates. The discussion flowing from the bottom of page 18 to the top of page 19 in Chapter 12 of the Course Notes also looks to aid an intuitive understanding of the appropriateness of the convexity adjustment. Best wishes David
