ch 02 hull fundamentals 8 the d

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Fundamentals of Futures and Options Markets, 8th Ed, Ch 2, Copyright John C. Hull 2!"

Mechanics of FuturesMarkets

Chapter 2

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Futures Contracts

Available on a wide range of underlyingsExchange traded

Specifications need to be defined: What can be delivered, Where it can be delivered, & When it can be delivered

Settled daily

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Convergence of Futures to Spot (Figure2.1, page 28)

Fundamentals of Futures and Options Markets, 8th Ed, Ch 2, Copyright John C. Hull 2!"3

Time Time

(a) (b)

Futures

Price

Futures

PriceSpot Price

Spot Price


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Margin

A argin is cash or ar!etable securitiesdeposited by an investor with his or her

bro!er"he balance in the argin account is

ad#usted to reflect daily settleent

$argin inii%es the possibility of a lossthrough a default on a contract

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Exampe of a Futures !ra"e (page 2#$%&)

An investor ta!es a long position in 2eceber gold futures contracts on'une ( contract si%e is )** o%+ futures price is S-).(* initial argin re/uireent is

S-.,***0contract 1S-)2,*** in total aintenance argin is

S-3,(**0contract 1S-4,*** in total



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' ossie *utcome (!ae 2.1, page %&)


ay "rade5rice 1-

Settle5rice 1-

aily6ain 1-

Cuul+6ain 1-

$argin7alance 1-

$arginCall 1-

) ),.(*+** )2,***

) ),.3)+** 8),9** 8 ),9** )*,2**

2 ),.9+* 8(3* 82,3* 4,..*

;++ ;++ ;++ ;++ ;;

. ),..+2* 8


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+e oints 'out Futures

"hey are settled daily Closing out a futures position involves

entering into an offsetting trade $ost contracts are closed out before

aturity

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Margin Cash Fo-s hen Futures

rice /ncreases



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Margin Cash Fo-s hen Futures

rice 0ecreases



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Coateraiation in *!C Markets

=t is becoing increasingly coon for transactionsto be collaterali%ed in >"C ar!ets

Consider transactions between copanies A and 7 "hese ight be be governed by an =SA $aster

agreeent with a credit support annex 1CSA "he CSA ight re/uire A to post collateral with 7

e/ual to the value to 7 of its outstanding transactionswith 7 when this value is positive+



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Coateraiation in *!C Marketscontinue"

=f A defaults, 7 is entitled to ta!epossession of the collateral

"he transactions are not settled dailyand interest is paid on cash collateral

See 7usiness Snapshot 2+2 for how

collaterali%ation affected ?ong "erCapital $anageent when there was a@flight to /uality in 2**9+



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Cearing ouses an" *!C

Markets

"raditionally transactions have beencleared bilaterally in >"C ar!ets

Bollowing the 2**"C derivatives

transactions to be cleared centrallythough clearing houses+



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3iatera Cearing vs Centra

Cearing ouse


7ilateral clearing Central clearing


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Some !erminoog

>pen interest: the total nuber ofcontracts outstanding e/ual to nuber of long positions or nuber

of short positions

Settleent price: the price #ust before thefinal bell each day used for the daily settleent process

Dolue of trading: the nuber of trades inone day



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>pen igh ?ow 5rior settle

?asttrade

Change Dolue

Aug 2*)2 9(+9. 9


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0eiver

=f a futures contract is not closed out before aturity, it isusually settled by delivering the assets underlying thecontract+ When there are alternatives about what isdelivered, where it is delivered, and when it is delivered,the party with the short position chooses+

A few contracts 1for exaple, those on stoc! indicesand Eurodollars are settled in cash

When there is cash settleent contracts are traded untila predeterined tie+ All are then declared to be closedout+

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Futures rice atterns

Butures prices can be an increasing function of aturity: noral

ar!et a decreasing function of aturity: inverted

ar!et partly noral, partly inverted



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6uestions

When a new trade is copletedwhat are the possible effects on theopen interestG

Can the volue of trading in a daybe greater than the open interestG

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!pes of *r"ers ?iit Stoploss Stopliit $ar!etif touched

Discretionary

Time of day

Open

Fill or kill



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7eguation of Futures

Hegulation is designed toprotect the public interest

Hegulators try to prevent/uestionable trading practicesby either individuals on the floorof the exchange or outsidegroups

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'ccounting !ax

=t is logical to recogni%e hedging profits1losses at the sae tie as the losses1profits on the ite being hedged

=t is logical to recogni%e profits and lossesfro speculation as they are incurred

Houghly spea!ing, this is what theaccounting and tax treatent of futures in

the +S+ and any other countries atteptsto achieve

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For-ar" Contracts

A forward contract is an >"Cagreeent to buy or sell an asset at acertain tie in the future for a certain

price "here is no daily settleent 1but

collateral ay have to be posted.Atthe end of the life of the contract oneparty buys the asset for the agreedprice fro the other party

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rofit from a 9ong For-ar" or

Futures osition

5rofit

5rice of nderlying

at $aturity

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rofit from a Short For-ar" or

Futures osition

5rofit

5rice of nderlying

at $aturity

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For-ar" Contracts vs Futures

Contracts (!ae 2.%, page :%)

Forward Futures

5rivate contract between two parties "raded on an exchange

Iot standardi%ed Standardi%ed

sually one specified delivery date Hange of delivery dates

Settled at end of contract Settled daily

elivery or final settleent usual sually closed out prior to aturity

Soe credit ris! Dirtually no credit ris!



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Foreign Exchange 6uotes

Butures exchange rates are /uoted as thenuber of S per unit of the foreign currency

Borward exchange rates are /uoted in the saeway as spot exchange rates+ "his eans that675, EH, A, and IJ are S per unit offoreign currency+ >ther currencies 1e+g+, CAand '5K are /uoted as units of the foreigncurrency per S+

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ch 02 hull fundamentals 8 the d

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