![Currencies Standard Contract Sizes:
• 1) British pound [ contract size = 62,500 ]
• 2) Euro [ contract size = 125,000 Euro]
• 3) Canadian dollar
• 4) Japanese yen
• 5) Deutsche mark
• 6) Australian dollar
• 7) Swiss franc](https://image.slidesharecdn.com/futuremarketsandcontracts-150912054845-lva1-app6891/85/Future-markets-and-contracts-28-320.jpg)
Future markets and contracts
- 2. In the financial marketplace some instruments are regarded as fundamentals, while others are regarded as derivatives. Financial Marketplace Derivatives Fundamentals Futures Forwards Options Swaps Stocks Bonds
- 3. An agreement between a buyer and a seller to receive or deliver a product on a future date at a price they have negotiated TODAY. What Is A Futures Contract?
- 4. Forward • Private contracts between two parties • Not standardize • Usually are one specific deliver date settle at end of contract • Delivery or final cash settlement takes place • Some credit risk exist Future • Traded on an exchange • Standardize contract • Range of delivery dates • Settled daily ( marked to market) • Contract is usually close out prior to maturity • No credit risk • Clearing house of the exchange guarantee payments to both parties
- 5. Contract standardized with respect to: Delivery Period (timing) Contract Size (quantity) Quality of the Product The manner of delivery Exchange set the Minimum price fluctuation ( Tick Size) Exchange also set the trading timings The only negotiable terms are price and the number of contracts involved in each trade.
- 6. Transaction will not be completed until some agreed-upon date in the future Delivery date and quantity are all set when the financial future is created Seller has legally binding obligation to make delivery on specified date Buyer/holder has legally binding obligation to take delivery on specified date Futures may be held until delivery date or traded on futures market All trading is done on a margin basis The futures price is simply what a buyer is willing to pay and a seller is willing to accept for a product. The exchange (CME, NYBT, CBOT) itself does not set prices. Once you’ve established a “long” (buy) or “short” (sell) position in the futures market, the value of your position (gain or loss) changes each time prices change.
- 8. • Hedger are in the position where they face risk associated with the price of an asset . They use derivative to reduce / eliminate risk • Example : Farmers will sell futures to guarantee the price at which they will be able to sell their wheat Using Future contract by Hedger • Speculator wish to bet on future movement in the price of an asset • They use derivative to get extra leverage – high return Using Future Contract by Speculators
- 9. Short Position • A Seller of a future contract has a short position • Short has an obligation to sell at contract price Long Position • A trader who contacts a broker and buys future is said to have a long position • The long has contracted to buy the asset at the contract price at contract expiration
- 10. When one “buys” a futures contract, one agrees with the exchange to a daily settlement procedure that is only loosely analogous to buying the commodity. One must post initial margin with the futures commission merchant. Usually, one has no intention of taking delivery of the commodity Same as when one “sells” a futures contract, no intention of selling the commodity. Again, post margin.
- 11. 15-12
- 12. Each Exchange has a clearinghouse Clearing house guarantees that traders in the future market will honor their obligations It acts as the buyer to every seller and the seller to every buyer Traders can easily reverse their positions from long to short at future date
- 13. Margin in Securities Markets • Margin on a stock/bond is a percentage of the market value of the asset • 50% of stock purchase by borrowed amount, interest charged on the borrowed amount is margin loan Margin in Future Markets • Margin is a performance guarantee. • It’s the money deposited by both the long and the short • No loan involved , no interest charges
- 14. Initial margin: The amount deposited in a future account . It equals about one day’s price settlement • If balance falls below maintenance margin , a margin call take place and fund must be added back to the amount of initial margin • If funds not added , position is liquid Maintenance margin: The amount of margin that must be maintained in a future account • Usually settled in cash with the broker each morning Variation margin – is the funds that must be deposited into the account to bring it back to the initial margin amount
- 15. • Daily Price limit ( up / down )= $ 0.02 Previous day settlement Price = $1.04 • No trade will take place • Settlement Price will be reported as $1.06 ( Mark to Market), • the contract will be LIMIT MOVE , PRICE => LIMIT UP If today traders wishes to trade at $1.07 • No trade will take place • Settlement Price will be reported as $1.02( Mark to Market ) , • the contract will be LIMIT MOVE , PRICE => LIMIT DOWN If Today traders wishes to trade below $1.02 Locked Limit
- 16. Five July Wheat Contracts Each contract covers 5,000 bushels Initial Margin per Contract = $ 150 => so for 5 contracts TOTAL Initial Margin = 5 * 150 = $ 750 Maintenance Margin per Contract = $ 100 => so for 5 contracts = 5 * 100 => $500 Price change of a cent $0.01 per bushel changes a contract value by = 5000 * 0.01 = $50 So each 5 contracts = 5 * $50 = $250
- 17. Day Required Deposit Price / Bushel Daily Change Gain / Loss Balance 0 ( Purchase) $750 $2.00 0 0 $750 1 0 $1.98 -$0.02 -$500 $250 2 $500 $1.99 +0.01 +250 $1000 3 0 $1.98 -0.01 -$250 $750
- 18. 4 ways to terminate a future contract Delivery :Short by delivering the goods ,long by paying price to short Cash Settlement Price Reversing Position Exchange for physicals
- 19. • Eurodollar • U.S. Treasury Bills Short term future contracts • U.S. Treasury NotesIntermediate Future Contracts • U.S. Treasury Bonds Long Term Future Contract
- 20. 21 T-bill price = Face value - Discount amount Days to maturity Discount amount = Face value ( ) Ask discount 360
- 21. U.S. Treasury bills Future Contracts: • Example • A 90-day (13 weeks) T-bill future contract , face value $1 Million. Price quote as $98.52 • Annualized discount %= (100 - 98.52 )/100 = 0.0148 or 1.48% • Actual Discount % = 0.0148 * (90 / 360 ) = 0.0037 • Discount Amount = Face Value * 0.0037 = $3,700 • Delivery Price = Face Value – Discount Amount • = $1000,000 - $3,700 = $996,300
- 22. U.S. Treasury bills / Eurodollar Tick Size • T-Bills / Eurodollar of 90 days of $1 Million Future Contract • Each change in Price of 1 cent ( $0.01) of a T-Bills / Eurodollar ,discount of 0.01 % • 0.01 %*( 90/360) * $ 1 Million = $25 • A price change 1 cent in T-bill / Eurodollar represent change of $25 in contract of $1 Million • e.g. Price falls from $98.52 to $98.50 , $50 loss per contract
- 23. T-notes have a life of less than ten year • T-bonds are callable fifteen years after they are issued U.S. Treasury bond futures: • Pay semiannual interest • Have a maturity of up to 30 years • Trade readily in the capital markets U.S. Treasury bonds differ from U.S. Treasury notes: • Call for the delivery of $100,000 face value of U.S. T-bonds • With a minimum of fifteen years until maturity (fifteen years of call protection for callable bonds) • Bonds that meet these criteria are deliverable bonds A conversion factor is used to standardize deliverable bonds: • The conversion is to bonds yielding 6 percent • Published by the Chicago Board of Trade • Is used to determine the invoice price
- 25. Suppose $1000 Treasury bond with 8% coupon, currently trading at 92, 6% short term rate If futures contract selling at 910: Now: Borrow funds +920 Buy bond -920 Sell Treasury futures 0 Net cash flow 0 One year later: Receive coupon +80 Deliver bond at contract price +910 Pay off loan -920 Pay off loan interest _55 Net cash flow +15 Which bond to buy? "Cheapest to deliver"
- 26. If futures contract selling at 880: Now: Short bond in cash market +920 Invest funds at 6% -920 Buy bond futures 0 Net Cash Flow 0 One year later: Receive loan principal +920 Receive loan interest +55 Pay coupon on shorted bond -80 Buy bond at contracted price -880 Deliver on bond ___ _ Net Cash Flow 15
- 27. Profit and loss of a futures transaction A march 2005 treasury bond futures contract traded on CBT on Jan. 10, 2005 is 112 11/32 (or 112.34375) percent of the face value of the T-bond. The contract size is $100,000. So the position can be taken with a price of $112,343.75. The subsequent movement of the T-bond futures price falls to 111-16 (111.5%), the long position incurs a loss of (111.5-112.34375)%*100,000 = -$843.75.
- 28. Currencies Standard Contract Sizes: • 1) British pound [ contract size = 62,500 ] • 2) Euro [ contract size = 125,000 Euro] • 3) Canadian dollar • 4) Japanese yen • 5) Deutsche mark • 6) Australian dollar • 7) Swiss franc
- 29. Currency Future :Long and Short Exposures A person that is, for example, long the pound, has pound denominated assets that exceed in value their pound denominated liabilities. A person that is short the pound, has pound denominated liabilities that exceed in value their pound denominated assets.
- 30. Hedging With a Currency Future To hedge a foreign exchange exposure, the customer assumes a position in the opposite direction of the exposure. For example, if the customer is long the pound, they would short the futures market. A customer that is long in the futures market is betting on an increase in the value of the currency, whereas with a short position they are betting on a decrease in the value of the currency.
- 31. Example The parent company has a foreign exchange exposure, as the dollar value of the profits will rise and fall with changes in the exchange value between the MP and the dollar. A US manufacturing company has a division that operates in Mexico. At the end of June the parent company anticipates that the foreign division will have profits of 4 million Mexican pesos (MP) to repatriate.
- 32. The firm is long the peso, so to hedge the exposure they will go short in the futures market. The face amount of each peso future contract is MP500,000, so the firm will go short 8 contracts. If the peso depreciates, the dollar value of the division’s profits falls, but the future account generates profits, at least partially offsetting the loss. The opposite holds for an appreciation of the peso.
- 33. Change spot value Change in futures price Gain Loss Underlying Long Position Futures Position This diagram illustrates the effect of a change in the value of the peso. An increase in the value of the peso increases the dollar value of the underlying long position and decreases the value of the futures position. A decrease in the value of the peso decreases the value of the underlying position and increases the value of the futures position.
- 34. On the 25th, the spot rate opens at 0.10660 ($/MP) while the price on a MP future opens at 0.10310. The market closes at 0.10635 and 0.10258 respectively. The loss on the underlying position is: •(0.10635-0.10660)MP4 mil. = - $1,000 The gain on the futures position is: •(0.10310- 0.10258)8MP500,000=$2,080 Gain and Loss on Underlying and Futures Position Day 1
- 35. Change spot value Change in futures price Gain Loss Underlying Long Position MP4 million Futures Position MP500,000 x 8 -0.00025 -0.00052 $1,000 $2,080 Gain and Loss on Underlying and Futures Position Day 1
- 36. On the 28th, the spot rate moves to 0.10670 ($/MP) and the price on a MP future to 0.10285. The gain on the underlying position is: • (0.10670-0.10635)MP4 mil. = $1,400 The loss on the futures position is: • (0.10258-0.10285)8MP500,000=-$1,080 Gain and Loss on Underlying and Futures Position Day 2
- 37. Change spot value Change in futures price Gain Loss Underlying Long Position MP4 million Futures Position MP500,000 x 8 $1,080 $1,400 0.00035 0.00032 Gain and Loss on Underlying and Futures Position Day 2
- 38. On the 29th, the spot rate moves to 0.10680 ($/MP) and the price on a MP future to 0.10290. The gain on the underlying position is: • (0.10680-0.10670)MP4 mil. = $400 The loss on the futures position is: • (0.10285-0.10290)8MP500,000=-$200 Gain and Loss on Underlying and Futures Position Day 3
- 39. Change spot value Change in futures price Gain Loss Underlying Long Position MP4 million Futures Position MP500,000 x 8 $200 $400 0.00005 0.0001 Gain and Loss on Underlying and Futures Position Day 3
- 40. For the three days considered, the underlying position gained $800 in value and the futures contracts yielded $800. The hedge was not perfect as the daily losses on the futures were less than the gains on the underlying position (day 2 and 3), and the daily gains on the futures exceeded the losses on the underlying position (day 1). In this example, the imperfect hedge yielded additional gains.