IF 2008 - chapter 12 (Futures)

国际金融论英文版教材第12章

IF 2008 – Chapter 12

Financial Futures

[Financial Derivatives Market: Overview]

Derivative financial products

Contracts or instruments whose value stems from that of some underlying financial

asset

Underlying Asset:

Commodities Equities Currencies Interest Rate Index

Derivative Products:

OPTIONS

FORWARDS FUTURES SWAPS

The list is constantly evolving.

Three Types of Users of Derivatives Products

Speculation Hedging Arbitraging

Over-the-Counter (OTC) Market

A security traded in some context other than on a formal or centralized exchange

such as the NYSE, TSX, LSE, etc.

The relationship between the holder and the writer is direct

International banks have tailored derivatives to the specific needs of their corporate

clients

This OTC market is open only to larger firms because it involves amounts in

millions of dollars

The major players are international investment banks

The customized nature of the market allows for the negotiation of the terms of the

contract between the holder and the writer

This market provides flexibility in fitting derivatives contracts to the specific needs

of a multinational firm Some shortcomings

The product buyer always faces the risk of nonperformance The holder is directly faced with the risk of default by the writer

The derivatives price may be misplaced due to such tailor-made

arrangement

The lack of standardization causes limited liquidity

Traded ( Listed ) Options

Standardized options which grant the buyer the right to buy or sell financial

国际金融论英文版教材第12章

instruments at standardized prices and dates in the future

A premium is charged for this right, and usually paid when the option is bought The Options Clearing Corporation guarantees every trade in options to the buyer

and for payment of the premium to the seller

According to the Underlying Financial Commodities

Currencies Bond Equity

According to the Contract Types

Forward/Future Options Swaps

According to the Trading Venue

Exchange

Over-the-Counter (OTC)

[Textbook]

Background

Hedgers vs Speculators Commodity Futures Financial Futures Index Futures Bond Futures

Interest Rates Futures Currency Futures

Some Problems of Future Exchanges Open Outcry or Computers Contract Volumes

国际金融论英文版教材第12章

A. Forward and Future Contract: Some Preliminaries

a) Forward Contract

Definition and some basic points

Contracting today for the future purchase or sale of financial commodities

Defined as a vehicle for buying or selling a stated amount of foreign exchange at a

stated price per unit at a specified time in the future

Forward prices may be the same as the spot price, but usually it is higher or lower than

the spot price

Forward Price > Spot Price At a Premium Forward Price < Spot Price At a Discount

Forward Rates for Foreign Currencies are quoted on most major currencies for a variety

of maturities

Bank quotes for maturities of 1, 3, 6, 9 and 12 months are readily available Quotations on non-standard, or broken-term, maturities are also available Maturities extending beyond one year are becoming more frequent

Forward Quotations on Foreign Currencies – an Example

Spot Rate ($/euro) = F1 ($/euro) = F3 ($/euro) = F6 ($/euro) =

From these quotations, we can see that in American terms the euro is trading at a

premium to the dollar

In European terms, the dollar is trading at a discount to the euro

Forward Positions

Bank customers can contract with their international bank to buy or sell a

specific sum of FX for delivery on a certain date

Likewise, interbank traders can establish a long or short position by dealing

with a trader from a competing bank

Long Position – buy foreign exchange forward Short Position – sell foreign exchange forward

Payoff in a Forward Contract – the determinants

Forward Position

Difference between Forward Price and Spot Price at maturity

Example

If you bought a 1m dollar forward contract in 3 month maturity at ¥9.50/$ 3 months later, the spot rate for ¥/$ changed to ¥9.65/$ You gain profit of ¥150,000

Suppose there is no transaction fee

国际金融论英文版教材第12章

Forward Quotation

Outright forward quotation

1.9678 – 1.9684

Forward point quotation

Forward points are subtracted from the spot prices 32 – 30 Advantages

- forward points may remain constant for long periods of time, even if the spot rates fluctuate frequently

- in swap transactions, the premium or discount differential, measured in forward points

________________________________________________________________ ($/£) Spot 1.9678 – 1.9684 1 month forward 32 – 30 3 month forward 57 – 54 6 month forward 145 – 138

________________________________________________________________

①. The British Pound is trading at a forward discount to the dollar ②. All bid prices are less than the corresponding ask prices – margin for

traders ③. The bid – ask spread increases in time to maturity

国际金融论英文版教材第12章

Forward Premium/Discount

Common to express the premium or discount of a forward rate as annualized

percentage deviation from the spot rate

The premium or discount is useful for comparing against the interest rate

differential between two countries American Terms

F3 = S($/£) * 360/days European Terms

F3 = S(£/$) * 360/days

b) Future Contract

Similarity and Difference with Forward

Both forward and futures contracts are classified as derivatives or contingent claim

securities because their values are derived from or contingent upon the value of the underlying security

Future contracts are similar to forward contract, but has many distinctions between

the two

Major difference between Forward and Futures

Forward

① tailor-made for a client by his international bank; traded on OTC ② states a price for the future transaction

Futures:

① standardized features and is traded on organized exchanges

Contract Size specifying the amount of the underlying foreign currency for future purchase or sale

Maturity Date of the contract – specific delivery months and a specific day

② Settlement Price - a future contract is settled up, or marked-to-market,

daily at the settlement price

Marking-to-Market Settlement

the settlement price of a future contract is a price representative of futures

transaction prices at the close of daily trading on the exchange

the marking-to-market feature of futures markets means that market participants

realize their profits or suffer their losses on a day-to-day basis rather than all at once at maturity as with a forward contract

Convergence of a future price to spot price: the final settlement price at which any

transaction in the underlying asset will converge through time to the spot price on the last day of trading in the contract