Chapter 22 Forward And Futures Contract

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Chapter 22Forward And Futures Contract
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Forward Contract

• Terminology
• Short position (Seller)
• Long position (Buyer)
• Current exchange rate
• Spot rate
• Forward rate

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Who Is Taking The Risk?

• Bank Operates as a Mediator
• Another Customer
• Takes the opposite position
• Risk Reduction if Parties do not Default

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Characteristics Of Futures Contract

• Traded on Organized Exchange
• Seller can Change Delivery Date
• Mark to Market Cash Settlement
• On a daily basis
• Reduces the risk of default

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Difference Between Forward And Futures Contract

• Forward
• Traded between partners
• Precise delivery date
• Cash or delivery on delivery date

• Futures
• Traded on Organized exchange
• Seller can chose
• Mark to market

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Reading Financial Data On Futures

• Major Types Of Future Contracts
• Settle Price
• Open Interest
• Cash Settlement

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Major Types Of Future Contracts

• Grains and oilseeds
• Livestock and Meat
• Food and Fiber
• Metals and Petroleum
• Currencies
• Interest Rates
• Stock Indexes

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Trading A Futures Contracts

• Initial Orders
• Buyers and sellers contact their brokers
• Futures commission merchants (FCMs)
• FCMs contact their floor brokers
• Trade executed
• After Trade is Executed
• Traders contact floor brokers regarding trading
  results
• Floor brokers contact clearinghouse
• Floor brokers contact FCMs
• FCMs contact buyers and sellers

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Clearinghouse

• Vital Roles
• Banker
• Provide for the exchange of profits and losses
• Inspector
• Insures good product Delivery
• Insurer
• Guarantees that each trader will honor the
  contract

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How Do Margin Requirements Work?

• Initial Margin
• Maintenance of Margin
• Performance Bond
• Insurance that both parties will fulfill their
  obligations

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Margin Cash Flow Over Time
Margin Cash Flow
Margin Call
Initial Margin
Maintenance Margin
Days
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Investment Strategies

• Hedging
• Speculating
• Arbitrage
• Portfolio Diversification

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Arbitrage

• Objective is to Design a Portfolio with
• No investment
• Positive cash flow
• No future liabilities
• Plays an important role in making the market
  efficient
• By trading on price discrepancies

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Pricing Futures Contracts

• Basis
• Stock Indexes
• Currency Futures
• Commodity Futures

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Futures Price Depends On

• Current Spot Price
• Risk-Free Interest Rate
• Time to Expiration
• Cost of Carrying the Underlying Asset
• Dividends

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Tools For Hedging Foreign Exchange Risk

• Futures
• Options
• Forward Contracts
• Swaps
• Futures Options

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Owners
Receive
Stock Index Portfolio Currency Commodity
Dividend Yield
Receive
Foreign Interest Rate
Cost of Storage
Pay