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Futures and Forwards
1. CHAPTER 19
Futures Markets (40 slides)INVESTMENTS  BODIE, KANE, MARCUS
McGrawHill/Irwin
Copyright © 2011 by The McGrawHill Companies, Inc. All rights reserved.
2. Futures and Forwards
192Futures and Forwards
• Forward – a deferreddelivery sale of an
asset with the sales price agreed on
now.
• Futures  similar to forward but feature
formalized and standardized contracts.
• Key difference in futures
– Standardized contracts create liquidity
– Marked to market
– Exchange mitigates credit risk
Ex next page
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3.
193INVESTMENTS  BODIE, KANE, MARCUS
4.
194INVESTMENTS  BODIE, KANE, MARCUS
5.
195INVESTMENTS  BODIE, KANE, MARCUS
6.
196INVESTMENTS  BODIE, KANE, MARCUS
7.
197INVESTMENTS  BODIE, KANE, MARCUS
8.
198INVESTMENTS  BODIE, KANE, MARCUS
9.
199INVESTMENTS  BODIE, KANE, MARCUS
10. Impact of leverage of futures
1910Impact of leverage of futures
Shanghai Shenzhen 300 index futures (margin=8%)
date
quote
20161014
change
profit
initial margin
ROA
ROE
3305.85 +20%
3967.02
661.17
264.468
0.2
2.5
20%
2644.68
661.17
264.468
0.2
2.5
Margin
HSI index futures
=74000/50
1480
23233
0.063702
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11. Basics of Futures Contracts
1911Basics of Futures Contracts
• A futures contract is the obligation to make or take
delivery of the underlying asset at a predetermined
price. Shanghai Shenzhen 300 index futures next 2
pages
• Futures price – the price for the underlying asset is
determined today, but settlement is on a future
date.
• The futures contract specifies the quantity and
quality of the underlying asset and how it will be
delivered.
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12.
1912INVESTMENTS  BODIE, KANE, MARCUS
13.
1913DAILY MARKET REPORT  HANG SENG INDEX
FUTURES
Contract *Openin *Daily
Month g Price High
Business Day
Prv. Business
Day
Thu 31 January 2002
Wed 30 January
2002
Settlem Change
ent
in
Price Settlem *Contra *Contra
*Daily
ent
Low
ct High ct Low Volume
HANG SENG INDEX  HK$50 Per Point
E
X
P
I
R
E
D
Jan02
Feb02
10850
Mar02
10777
Jun02
10837
Sep02
10780
10980
10655
10907
10590
10837
10579
10780
10780
10740
10675
10636
10612
15
10
21

11950
10655
11880
8851
11865
10405
10780
10780
Open Change
Interest in O.I.
4388
5037
19271
34802
+707
364
909
+29
16
764
1
0
0
1
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40863
4302 KANE, MARCUS
Contract Total
14. Shanghai Shenzhen 300 index futures
1914Shanghai Shenzhen 300 index futures
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15. Dalian commodity exchange
1915Dalian commodity exchange
Corn
Soybean Meal
Product
LLDPE
Coking Coal
No.1 Soybeans
No.2 Soybeans
Soybean Oil
RBD Palm Olein
PVC
Coke
Iron Ore
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16. Basics of Futures Contracts
1916Basics of Futures Contracts
• Long – a commitment to purchase the
commodity on the delivery date.
• Short – a commitment to sell the
commodity on the delivery date.
• Futures are traded on margin.
• At the time the contract is entered into, no
money changes hands.
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17. Basics of Futures Contracts
1917Basics of Futures Contracts
• Profit to long = Spot price at maturity  Original
futures price
• Profit to short = Original futures price  Spot
price at maturity
• The futures contract is a zerosum game, which
means gains and losses net out to zero.
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18. Figure 19.2 Profits to Buyers and Sellers of Futures and Option Contracts
1918Figure 19.2 Profits to Buyers and Sellers
of Futures and Option Contracts
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19. Figure 19.2 Conclusions
1919Figure 19.2 Conclusions
• Profit is zero when the ultimate spot price,
PT equals the initial futures price, F0 .
• Unlike a call option, the payoff to the long
position can be negative because the
futures trader cannot walk away from the
contract if it is not profitable.
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20. Existing Contracts
1920Existing Contracts
• Futures contracts are traded on a wide
variety of assets in four main categories:
1.
2.
3.
4.
Agricultural commodities
Metals and minerals
Foreign currencies
Financial futures
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21. Trading Mechanics
1921Trading Mechanics
• Electronic trading
has mostly
displaced floor
trading.
• CBOT and CME
merged in 2007 to
form CME Group.
• The exchange acts
as a clearing house
and counterparty to
both sides of the
trade.
• The net position of
the clearing house is
zero.
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22. Trading Mechanics
1922Trading Mechanics
• Open interest is the number of contracts
outstanding.
• If you are currently long, you simply
instruct your broker to enter the short side
of a contract to close out your position.
• Most futures contracts are closed out by
reversing trades.
• Only 13% of contracts result in actual
delivery of the underlying commodity.
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23. Figure 19.3 Trading without a Clearinghouse; Trading with a Clearinghouse
1923Figure 19.3 Trading without a Clearinghouse;
Trading with a Clearinghouse
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24. Margin and Marking to Market
1924Margin and Marking to Market
• Marking to Market  each day the profits or
losses from the new futures price are paid
over or subtracted from the account
• Convergence of Price  as maturity
approaches the spot and futures price
converge
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25. Margin and Trading Arrangements
1925Margin and Trading Arrangements
• Initial Margin  funds or interestearning
securities deposited to provide capital to
absorb losses
• Maintenance margin  an established value
below which a trader’s margin may not fall
• Margin call  when the maintenance margin
is reached, broker will ask for additional
margin funds
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26. Trading Strategies
1926Trading Strategies
Speculators
• seek to profit from price
movement
– short  believe price will fall
– long  believe price will rise
Hedgers
• seek protection from price
movement
– long hedge  protecting
against a rise in purchase
price
– short hedge  protecting
against a fall in selling price
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27. Basis and Basis Risk
1927Basis and Basis Risk
• Basis  the difference between the
futures price and the spot price, FT –
PT
• The convergence property says FT –
PT= 0 at maturity.
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28. Basis and Basis Risk
1928Basis and Basis Risk
• Before maturity, FT may differ
substantially from the current spot
price.
• Basis Risk  variability in the basis
means that gains and losses on the
contract and the asset may not
perfectly offset if liquidated before
maturity.
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29. Futures Pricing
1929Futures Pricing
Spotfutures parity theorem  two ways
to acquire an asset for some date in the
future:
1. Purchase it now and store it
2. Take a long position in futures
•These two strategies must have the
same market determined costs
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30. SpotFutures Parity Theorem
1930SpotFutures Parity Theorem
• With a perfect hedge, the futures payoff
is certain  there is no risk.
• A perfect hedge should earn the
riskless rate of return.
• This relationship can be used to
develop the futures pricing relationship.
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31. Hedge Example: Section 19.4
1931Hedge Example: Section 19.4
• Investor holds $1000 in a mutual fund
indexed to the S&P 500.
• Assume dividends of $20 will be paid on
the index fund at the end of the year.
• A futures contract with delivery in one
year is available for $1,010.
• The investor hedges by selling or
shorting one contract .
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32. Hedge Example Outcomes
1932Hedge Example Outcomes
Value of ST
990
1,010
1,030
Payoff on Short
(1,010  ST)
Dividend Income
Total
20
0
20
20
20
20
1,030
1,030
1,030
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33. Rate of Return for the Hedge
1933Rate of Return for the Hedge
( F0 D ) S 0
S0
(1,010 20) 1,000
3%
1,000
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34. The SpotFutures Parity Theorem
1934The SpotFutures Parity Theorem
( F0 D ) S 0
rf
S0
Rearranging terms
F0 S 0 (1 r f ) D S 0 (1 r f d )
d D
S0
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35. Arbitrage Possibilities
1935Arbitrage Possibilities
• If spotfutures parity is not observed,
then arbitrage is possible.
• If the futures price is too high, short the
futures and acquire the stock by
borrowing the money at the risk free rate.
• If the futures price is too low, go long
futures, short the stock and invest the
proceeds at the risk free rate.
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36. Spread Pricing: Parity for Spreads
1936Spread Pricing: Parity for Spreads
T
F (T1 ) S0 (1 rf d ) 1
T
F (T2 ) S0 (1 rf d ) 2
F (T2 ) F (T1 )(1 rf d )
( T 2 T 1 )
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37. Spreads
1937Spreads
• If the riskfree rate is greater than the
dividend yield (rf > d), then the futures
price will be higher on longer maturity
contracts.
• If rf < d, longer maturity futures prices will
be lower.
• For futures contracts on commodities that
pay no dividend, d=0, F must increase as
time to maturity increases.
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38. Figure 19.6 Gold Futures Prices
1938Figure 19.6 Gold Futures Prices
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39. Futures Prices vs. Expected Spot Prices
1939Futures Prices vs. Expected Spot
Prices
• Expectations F0=E(PT), PT = future spot price
• Normal Backwardation: futures price bid down to a level
below E(PT) as speculators needs a profit of F0E(PT) to
long the contract
• Contango: F0<E(PT) as the natural hedgers are the
purchasers of a commodity and want to hedge their
purchase at T
• Modern Portfolio Theory: if commodity prices pose
positive systematic risk, futures prices must be lower
than expected spot prices: F0=E(PT)[(1/rf)/(1+k)]T
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40. Figure 19.7 Futures Price Over Time, Special Case
1940Figure 19.7 Futures Price Over Time,
Special Case
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