CHAPTER 19
Futures and Forwards
Impact of leverage of futures
Basics of Futures Contracts
Shanghai Shenzhen 300 index futures
Dalian commodity exchange
Basics of Futures Contracts
Basics of Futures Contracts
Figure 19.2 Profits to Buyers and Sellers of Futures and Option Contracts
Figure 19.2 Conclusions
Existing Contracts
Trading Mechanics
Trading Mechanics
Figure 19.3 Trading without a Clearinghouse; Trading with a Clearinghouse
Margin and Marking to Market
Margin and Trading Arrangements
Trading Strategies
Basis and Basis Risk
Basis and Basis Risk
Futures Pricing
Spot-Futures Parity Theorem
Hedge Example: Section 19.4
Hedge Example Outcomes
Rate of Return for the Hedge
The Spot-Futures Parity Theorem
Arbitrage Possibilities
Spread Pricing: Parity for Spreads
Spreads
Figure 19.6 Gold Futures Prices
Futures Prices vs. Expected Spot Prices
Figure 19.7 Futures Price Over Time, Special Case
4.73M
Category: financefinance

Futures and Forwards

1. CHAPTER 19

Futures Markets (40 slides)
INVESTMENTS | BODIE, KANE, MARCUS
McGraw-Hill/Irwin
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Futures and Forwards

19-2
Futures and Forwards
• Forward – a deferred-delivery 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.

19-3
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4.

19-4
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5.

19-5
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6.

19-6
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7.

19-7
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8.

19-8
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9.

19-9
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10. Impact of leverage of futures

19-10
Impact 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

19-11
Basics 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.

19-12
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13.

19-13
DAILY 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
Jan-02
Feb-02
10850
Mar-02
10777
Jun-02
10837
Sep-02
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
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Contract Total

14. Shanghai Shenzhen 300 index futures

19-14
Shanghai Shenzhen 300 index futures
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15. Dalian commodity exchange

19-15
Dalian 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

19-16
Basics 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

19-17
Basics 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 zero-sum 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

19-18
Figure 19.2 Profits to Buyers and Sellers
of Futures and Option Contracts
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19. Figure 19.2 Conclusions

19-19
Figure 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

19-20
Existing 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

19-21
Trading 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

19-22
Trading 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 1-3% 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

19-23
Figure 19.3 Trading without a Clearinghouse;
Trading with a Clearinghouse
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24. Margin and Marking to Market

19-24
Margin 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

19-25
Margin and Trading Arrangements
• Initial Margin - funds or interest-earning
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

19-26
Trading 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

19-27
Basis 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

19-28
Basis 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

19-29
Futures Pricing
Spot-futures 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. Spot-Futures Parity Theorem

19-30
Spot-Futures 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

19-31
Hedge 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

19-32
Hedge 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

19-33
Rate of Return for the Hedge
( F0 D ) S 0
S0
(1,010 20) 1,000
3%
1,000
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34. The Spot-Futures Parity Theorem

19-34
The Spot-Futures 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

19-35
Arbitrage Possibilities
• If spot-futures 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

19-36
Spread 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

19-37
Spreads
• If the risk-free 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

19-38
Figure 19.6 Gold Futures Prices
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39. Futures Prices vs. Expected Spot Prices

19-39
Futures 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 F0-E(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

19-40
Figure 19.7 Futures Price Over Time,
Special Case
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