Transcript FINC4101 Investment Analysis

FINC4101
Investment Analysis
Instructor: Dr. Leng Ling
Topic: Introduction to Futures
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Learning objectives
1. Define futures contracts.
2. Understand the various features of futures: price,
maturity, margins, etc.
3. Describe how futures trading is organized.
4. List the positions of futures contracts.
5. Marking to market.
6. Trading strategies.
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Forwards
An agreement between two parties to exchange cash
for a commodity or financial asset at some specific time
in the future at a predetermined price.
1.
Terms are unique to each individual forward contract.
That is, each contract is customized.
2.
There is a risk that one side might default on its’
obligation.
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Forwards
Example:
Cotton is now traded at $1000 per ton in spot market.
You would like to purchase one ton and receive it 111
days from today. You would like to enter into a “forward
contract”.
I am willing to accommodate you in this desire. Now we
must agree on the forward price that you must pay me
after 111 days and how the commodity will be delivered.
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Futures
A standardized “forward contract” traded on an
organized and regulated futures exchange.
1.
Futures contracts are guaranteed by the exchange’s
clearinghouse that eliminates the risk of the other
party’s default.
2.
Each contract is standardized on the quantity,
quality, delivery place, delivery date, contract
expiration date.
3.
A deposit called “margin” is required to both buyers
and sellers.
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Standardized Contract Terms
Example: a CBOT wheat Futures contract
 Quantity: 5,000 bushels
 Commodity type: No.2 Soft Red, etc.
 Expiration: July, September, December, March,
and May
 Delivery place: in a warehouse approved by
CBOT
 Minimum price change (tick size): 0.25 cents per
bushel or $12.50 per contract.
Clearinghouse
Guarantees that all traders in the futures
markets will honor their obligations.
 Act in a position of buyer to every seller and
seller to every buyer. So no default risk as a
counter-party to every trader.

Goods
Buyer
Goods
Clearinghouse
Funds
Seller
Funds
Forwards vs. Futures
1.
2.
3.
4.
5.
6.
Futures contracts trade on an organized exchange.
Futures positions can be closed or transferred easily.
Futures contracts have standardized terms (quantity,
expiration, etc.)
Futures contracts are guaranteed by the clearinghouse
associated with the exchange.
Futures are subject to daily settlement (marked to the
market).
Margin is required to both the buyer and seller.
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Futures and Options
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Margin and Daily Settlement
Initial margin (5-15% of the underlying asset’s value)
 Maintenance margin
 Marking to market: realize any loss or profit in cash
every day.
Example: Long an oat future in CBT, 5000 bushels, initial
margin is $1,400, maintenance margin is $1100.

day
1
2
3
Price (cent/bushel) Contract value ($) Profit/Loss ($) Margin value ($)
171
8,550
0
1,400
168
8,400
-150
1,250
164
8,200
-200
1,050
Margin Call
Another Example of Margin
(example 17.1)
Suppose the maintenance margin is 5% while
the initial margin was 10% of the value of the
corn futures that has 5,000 bushes. At day 0, the
price of the future is 353.25 cents/bushel.
 Q1: how much initial margin does the buyer or
seller need to deposit at day 0?
 Q2: at what price does the buyer receive a
margin call?
 Q3: at what price does the seller receive a
margin call?

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Margin and Leverage
Initial margin is10%; current oil futures price is
$39.48; contract size of 1,000 barrels.
 Initial margin: 0.1*39.48*1000=$3,948


If price increases by $2 (5.0659%=2/39.48), then gain
=2*1000=$2000/contract (2000/3948=50.659%), which
is 10 times the percentage change in price.
leverage: 10--1
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Another Example of
Marking to Market
 Example
17.2 (page 552)
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Closing a Position



Delivery
Offset – reverse trade
Cash settlement: make payment at expiration date to
settle any gains or losses, instead of making physical
delivery.
Zero Sum Game
At maturity date T:
Profit to long = PT - original futures price
Profit to short = Original futures price - PT
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Main Futures Exchanges
CME group
 CME
 CBOT
 COMEX
 NYMEX
Types of Futures
Commodities: wheat, oat, cotton
 Foreign currencies: euro, British pound,
Canadian dollar, Japanese yen.
 Interest-earning assets: Treasury notes and
bonds, Eurodollar deposits
 Indexes: S&P500, Dow Joes, NASDAQ 100
 Individual stocks, e.g., IBM.

Participants in Futures Markets
 Hedgers:
hedging, risk management
 Speculators: make money by taking risk
 Brokers: receive commission fee
 Regulators: futures exchanges and
clearinghouses, the National Futures
Association, the Commodity Futures
Trading Commission
Treasury Bill Futures

Trading cycles: Mar/Jun/Sep/Dec

the underlying: the $1 million T-bill with 90-day maturity.

No actual delivery, cash settlement.

quotation: CME IMM index = 100.00 – Discount Yield
Example of Treasury Bill Futures Quotations
T-bill Futures Example
Jim Sanders purchased a T-bill futures
with the price of 94.00 (a 6% discount) and
that the price as of the March settlement
date is 94.90 (a 5.1 % discount). What is
the profit from the trade?
94.9%x1,000,000-94.00%x1,000,000=9,000
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T-bill Futures Example 2
Jim Sanders purchased a T-bill futures
with the price of 94.00 (a 6% discount) and
that the price as of the March settlement
date is 92.50 (a 7.5 % discount). What is
the profit from the trade?
92.5%x1,000,000-94.00%x1,000,000=15,000
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T-Bond Futures (maturity is over 10 years)
Treasury Bond Futures (quotation on page
546)





Trading cycles: Mar/Jun/Sep/Dec
Quotations in points and 32nd of par. e.g., 97-26
(97.8215)
Underlying: $100,000 worth (face value) of deliverable TBonds
Cash settlement or delivery
Tick size is 1/32nd of 0.01 (1/32x0.01x$100,000=$31.25)
T-bond Futures Example
A speculator purchased a futures on
Treasury bond at a price of 90-00. One
month later, the speculator sells the
same contract at 92-10. Given the par
value of the contract is $100,000, what
is the profit?
(92+10/32)x0.01x100,000 - (90+00/32)0.01x100,000
=2,312.50
Interest Rate and Futures Price
General rule for interest rate futures price:
 If
interest rates are expected to go up, the
price of interest rate futures will go down,
and vice verse.
Stock Index Futures Contracts

Main stock index futures
See next slide

Features:
 Cash settlement
 Trading cycle (March, June, September,
December)
 Different contract dollar multipliers

Quotations for stock index futures. (Figure 17.1)
Stock Index Futures Contracts
Stock Index Futures Example 1
The spot S&P500 index is 1300. Boulder Insurance
company plans to purchase a variety of stocks for its
stock portfolio in December. It anticipates a large jump in
stock market before December. The futures price on the
S&P500 index with a December settlement date is 1500.
The value of an S&P500 futures contract is $250 times
the index. If the S&P500 index rises to 1600 on the
settlement date, what is the profit if the company buy
one future now?
1600x250-1500x250=$25,000
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Stock Index Futures Example 2
Assume that a portfolio manger has a well diversified
stock portfolio valued at $2,000,000. Also assume that
S&P500 index futures contracts are available for a
settlement date one month from now at a level of 1600,
which is equal to today’s index value. How does the
manager do to hedge the stock portfolio?
Sell futures. $2,000,000/(1600x$250)=5 contracts
If market goes down by 5%, then …
If market goes up by 5%, then …
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Single Stock Futures
a. A contract to buy or sell a single stock
(usually 100 shares)
b. Settlement dates are quarterly
c. Offer potentially high returns (with high
risk)
d. Closing out involves taking opposite
position anytime before settlement date
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Speculating with Oil Futures
 Example
17.3 (page 554)
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Hedging with Oil Futures
 Example
17.5 (page 554)
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Spot-Futures Parity
 Page
557
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Arbitrage (Example 17.8)
 Page
558.
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Homework Assignment 12
 Chapter
17:
1,3,4,5,11,13,19
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