fins1612 summaries - week 10 - futures and forwards

8/17/2019 FINS1612 Summaries - Week 10 - Futures and Forwards

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FINS1612 – SUMMARIES

Week 10Futures Contracts and Forward Rate

AgreementsNote: These are both derivatives because they derive their price

from an underlying physical or nancial market product.

1! – "edg#ng Us#ng Futures Contracts$

• The purpose of derivative contracts is to enable investors and borrowers to

protect assets and liabilities against the risk of changes in interest rates,

exchange rates and share prices via %edg#ng&

o "edg#ng is the transferring of risk of unanticipated changes in prices,

interest or exchange rates to another party.

The change in the market price of a commodity or security is

oset by a prot or loss on the futures contract.

• Two main types of derivative product:

o Commod#t' (old, wheat, cattle etc!

o F#nanc#a( (shares, "#, money market instruments etc!

• $ futures contract is an agreement to buy or sell a specied asset at a

specied time in the future.

o #uy futures ()*N+ ,*SI-I*N! % agreement to .u' an asset in the

future.

o &ell 'utures (S"*R- ,*SI-I*N! % agreement to se(( an asset in the

future

/ec#s#on ru(e or utures$

o hat you want to do with the asset in the future ) do in the futures

market now

***hat position you have in the asset now, take the opposite

position in the futures

$ farmer concerned with wheat prices and wanting to SE)) in

the future should do that in the futures market now+ SE))

S%ort os#t#on.


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2! – Ma#n Features o Futures -ransact#ons$

• These are genera((' standard#sed but variation exists between countries.

o This is due to the under('#ng secur#t#es being traded being dierent

(&ydney futures exchange is dierent to "#T, "hicago board of

trade!

o $lso, there is dierences in the 3uotat#on con4ent#on:

***"lean price bond -uotation in & and /0 (12 minus accrued

interest!

***3T4 bond -uotation in $& markets.

&pecial note: "lean price is more stable than 5dirty6 price as

clean price only changes for economic reasons such as interest

rate change or issuer credit rating. 7irty prices change eachday depending on time to coupon payments $& /88 as the

economic reasons.

• *rders and agreement to trade (standard#sed art!+

o hether it is buy9sell order

o Type of contract (varies between exchanges!

o 7elivery month 9 expiration

o 1rice restrictions (such as a limit order!

o Time limits on the order

Marg#n re3u#rements$

o The buyer (long position! and the seller (short position! both a' an

#n#t#a( marg#n5 %e(d .' t%e c(ear#ng %ouse, rather than the full

price of the contract.

This is imposed to ensure traders are a.(e to a' for any

losses they incur owing to unfavourable price movements in the

contract.

o $ contract is markedtomarket on a daily basis by the clearing

house

***repricing the contract daily to re;ect current market valuations.

o Marg#n ca((s may be made, re-uiring the contract holder to pay a

maintenance margin to top up the initial margin to cover adverse

price movements.

C(os#ng out o a contract$

o ‘Entering into an opposite position’


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n etc!

$gricultural (wool, coee, butter, wheat, cattle! amongst others


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o 'inancial:

"urrencies (pound, sterling, euro etc!


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;! – Futures Market ,art#c#ants$The four categories of participants provide depth and liquidity to the futures

market improving its e!ciency.

18 "edgers$

o $ttempt to reduce the price risk from exposure to changes in interestrates, exchange rates and share prices

o -ake t%e oos#te os#t#on to t%e under(#ng5 eosed5

transact#on


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>! – "edg#ng$ R#sk Management us#ng Futures

'utures contracts may be used to manage identied nancial risk

exposures. 'or example:


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6! R#sks #n us#ng Futures markets or "edg#ng$

Standard contact s#?e$

o The physical market exposure may not exactly match the futures

market exposure, making a perfect hedge impossible.

Marg#n ,a'ments$

o


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!! Forward Rate Agreements 7FRAs8$

W%at #s #tB

'0$ is an overthecounter product enabling the management of an interest

rate risk exposure.

o $n agreement between two parties on an interest rate level that will

apply at a specied future date.

o $llows the lender and borrower to lock in interest rates

o nlike a loan, no ec%ange o r#nc#a( occurs

1ayment between the two parties involves the dierence

between the agreed interest rate and the actual interest rate at

settlement.

Ad4antages$

o Tailormade, T" contract with good ;exibility with respect to period

and amount of each contract.

o nlike futures contract ) '0$ does N*- "AE MAR+IN ,A=MEN-S

/#sad4antages$

o "redit risk (risk of nonsettlement!

o No orma( market e#sts

Sec#@cat#onsB

o '0$ agreed date, xed at start of '0$

o Eotional principal amount of the interest cover

o '0$ settlement date when compensation paid

o "ontract period on which the '0$ interest rate cover is based (end

date!

o 0eference rate to be applied at the settlement date


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Sett(ement Mat%emat#cs and num.ersB

o The settlement amount

% '0$ settlement rate ) '0$ agreed rate:

o

o here:

is % reference rate at the '0$ settlement date, expressed as a

decimal

ic % the xed '0$ agreed rate, expressed as a decimal

" % the number of days in the contract period

# % the '0$ notional principal amount

Eam(e$

n B? &eptember this year a company wishes to lock in the interest rate on

a prospective borrowing of FG @@@ @@@ for a sixmonth period from B? $pril

next year to B? ctober of the same year. $n '0$ dealer -uotes 5H4vBA4

(B?! BA.CG to C@6. n B? $pril the ##& on B?@day money is BA.?GI per

annum.

o i s 0&19D> 7on 1D Ar#(8

o i c 0&19D> 7on 1D Setem.er8

o D 19 da's 7rom 1D Ar#( to 1D *cto.er8

o P >

000 000


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7ue to interest rates rising over the period ) the settlement amount is paid

by the '0$ dealer to the company.

fins1612 summaries - week 10 - futures and forwards

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