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Futures and Forward Markets

The document discusses futures and forward markets. It defines a futures contract as an agreement to buy or sell an asset at a future date for a predetermined price. The party that agrees to buy has a long position while the party that agrees to sell has a short position. Futures are exchange-traded, involve daily settlement, and delivery occurs within a range of dates. Forwards are over-the-counter, involve settlement at delivery, and have a specific delivery date. Regulators seek to prevent illegal market activities like fraud and manipulation.

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Alex Shi
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95 views

Futures and Forward Markets

The document discusses futures and forward markets. It defines a futures contract as an agreement to buy or sell an asset at a future date for a predetermined price. The party that agrees to buy has a long position while the party that agrees to sell has a short position. Futures are exchange-traded, involve daily settlement, and delivery occurs within a range of dates. Forwards are over-the-counter, involve settlement at delivery, and have a specific delivery date. Regulators seek to prevent illegal market activities like fraud and manipulation.

Uploaded by

Alex Shi
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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2.

Futures and Forward Markets

2.1. Institutions

What is a Futures?

A futures contract is an agreement to buy or sell an asset at a certain time in the future

for a certain price (i.e., the delivery price) As opposed to a spot contract, which is an agreement to buy or sell an asset immediately for a certain price (i.e., the spot price)

The Long and Short of It

The party that has agreed to buy has a long position.

The party that has agreed to sell has a short position.

Examples of Futures Contracts

An agreement in September to buy L62,500

for $89,137.50 (= L62,500 $1.4262 per L)

An agreement to sell 25,000 pounds of copper in August for $20,187.50 (=25,000 pounds 80.75 cents per pound)

Newspaper Quotes

Asset, Exchange, Contract Size, Price Unit, Delivery Date

Prices: Open, High, Low, Settle, Change, Lifetime High, Lifetime Low

Open Interest, Volume

Denitions

Settlement price: average of prices at which the contract traded immediately before the close

Open interest: total number of contracts outstanding (= number of long positions = number of
short positions)

Trading volume: number of trades

Dierences between Futures and Forwards A futures contract is: Exchange traded (not customized) Settled daily (no credit risk) Deliverable within a range of dates

Typically closed out prior to delivery As opposed to a forward contract, that is: Traded OTC (customized) Settled at delivery (credit risk) Deliverable on a specic day

Typically delivered

Futures Price versus Forward Price

The futures price for a contract is typically very close to the forward price for the same contract.

The pricing dierence may be due to the marking to market of the futures contract. Further reading: Cox, Ingersoll, and Ross Journal of Financial
Economics 1989.

Marking to Market Margin requirement: initial funds deposited with the broker to trade futures contracts Maintenance margin: minimum account balance tolerated Margin call: call, when margin balance < maintenance margin, to put up the variation margin or liquidate Variation margin: funds, equal to margin requirement account balance, added to the margin account upon receiving a margin call

Clearinghouse

You!your !your !Exchangemy my Me broker oor oor broker broker broker # # your ! Clearinghouse my clearing clearing member member

Regulation

The Commodity Futures Trading Commission (CFTC) and the National Futures Assocition (NFA) want to protect the public from: Bucketing Cherry picking Chumming Churning

Elbow trading Front running and other illegal activities

Taxes

Recognize prots (losses) of a hedge at the same time as the asset being hedged.

Recognize prots (losses) of a speculative position on a mark to market basis.

Homework 1. (Hull 2.3) Suppose that you enter into a short futures contract to sell July silver for $5.20 per ounce on the New York Commodity Exchange. The size of the contract is 5,000 ounces. The initial margin is $4,000 and the maintenance margin is $3,000. What change in the futures price will lead to a margin call? What happens if you do not meet the margin call? 2. (Hull 2.11) An investor enters into two long futures contracts on frozen orange juice. Each contract is for the delivery of 15,000 pounds. The current futures price is 160 cents per pound, the initial margin is $6,000 per contract, and the maintenance margin is $4,500 per contract. What price change would lead to a margin call? Under what circumstances could $2,000 be withdrawn from the margin account? 3. (Hull 2.15) At the end of one day a clearinghouse member is long 100 contracts, and the settlement price is $50,000 per contract. The original margin is $2,000 per contract. On the following day the member becomes responsible for clearing an additional 20 long contracts, entered into at a price of $51,000 per contract. The settlement price at the end of this day is $50,200. How much does the member have to add to its margin account with the exchange clearinghouse? 4. (Baby Hull 2.24, Papa Hull 2.26) A company enters into a short futures contract to sell 5,000 bushels of wheat for 250 cents per bushel. The initial margin is $3,000 and the maintenance margin is $2,000. What price change would lead to a margin call? Under what circumstances could $1,500 be withdrawn from the margin account?

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