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Chapter 1.2 Futures

This document provides an introduction to derivatives and outlines the key concepts covered in a course on derivatives and risk management. The course aims to define derivative securities such as options, futures, and swaps; explain how they operate within economic environments; apply valuation methods to price these instruments; analyze accounting issues; and evaluate risk analysis frameworks. The document introduces forward and futures contracts, covering their features, limitations, terminology, pricing, and examples of equity index futures pricing when dividends are considered.

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17 views

Chapter 1.2 Futures

This document provides an introduction to derivatives and outlines the key concepts covered in a course on derivatives and risk management. The course aims to define derivative securities such as options, futures, and swaps; explain how they operate within economic environments; apply valuation methods to price these instruments; analyze accounting issues; and evaluate risk analysis frameworks. The document introduces forward and futures contracts, covering their features, limitations, terminology, pricing, and examples of equity index futures pricing when dividends are considered.

Uploaded by

Ankita
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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USB: MBA – Industry Collaborated Programs

Subject Name: Derivatives and Risk Management


Course Code: 21BFA713
Instructor: Dr. Nikhil Kaushik| E11022

Introduction to Derivatives
DISCOVER . LEARN . EMPOWER
Unit-1
Course Outcomes
CO Number Title
CO1 To define and discuss financial instruments such as
options, futures, swaps and other derivative securities
CO2 To be able to understand the economic environment in
which such instruments operate
CO3 To apply the knowledge gained via employing
theoretical valuation methods to price these financial
instruments
CO4 To analyse various accounting issues in derivatives
CO5 To evaluate Risk Analysis in accordance with
developing management framework. 2
Forward Contract
Agreement to buy or sell an asset
• Specified date
• Specified price
• One of the parties to the contract assumes a long position
and agrees to buy the underlying asset
• Other party assumes a short position and agrees to sell the
asset
• Contract details like delivery date, price and quantity are
negotiated bilaterally by the parties
3
Salient features of forward contracts
• Bilateral contracts and hence exposed to counter-party risk.
• Contract is custom designed, and hence is unique in terms of
contract size, expiration date and the asset type and quality.
• The contract price is generally not available in public domain.
• On the expiration date, the contract has to be settled by delivery
of the asset.
• If the party wishes to reverse the contract, it has to compulsorily
go to the same counter-party, which often results in high prices
being charged.
4
Limitations of forward markets
• Lack of centralization of trading,
• Liquidity
• Counterparty risk

5
Future Contract
Agreement to buy or sell an asset
• Specified date
• Specified price
• Unlike forward contracts, the futures contracts are
standardized and exchange traded.

6
Future Contract (cont.)
To facilitate liquidity in the futures contracts
• standardized contract with standard underlying
instrument,
• a standard quantity
• a standard timing of such settlement

7
Futures Terminology
• Spot Price
• Futures price
• Contract cycle
• Expiry date
• Contract size
• Initial margin
• Maintenance Margin
• Tick Size
8
Position in Derivatives
• Long Position
• Short Position

9
Payoff for a buyer of futures

10
Payoff for a seller of futures

11
Pricing Futures
F = SerT , where
S = Spot Price
r = Cost of financing (using continuously compounded interest rate)
T = Time till expiration in years
E = 2.71828

12
Example

Security XYZ Ltd trades in the spot market at Rs.


1150. Money can be invested at 11% p.a. The fair
value of a one-month futures contract on XYZ is
calculated
F = 1150 * e .11 * 1/12
= 1160

13
Pricing equity index futures
The main differences between commodity and equity index
futures are that:
1. There are no costs of storage involved in holding equity.
2. Equity comes with a dividend stream, which is a negative cost
if you are long the stock and a positive cost if you are short the
stock.
Therefore, Cost of carry = Financing cost -
Dividends.

14
Example
A buys a 2 month Nifty future contract at Rs. 4000. NSE
declaring a dividend of Rs.20 per share after 15 days of
purchasing the contract. Traded unit of Nifty involves 200
shares. Money can be borrowed at a rate of 10% per annum.
F = 4000 e .1 * 60/365 – 200 * 20 * e .1 * 45/365
100
This is the case when we know expected dividend amount.

15
Pricing index futures given expected dividend yield

F = Se(r-q)T, where
F = futures price
S = spot index value
r = cost of financing
q = expected dividend yield
T = holding period

16

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