Presentation on theme: "FINC4101 Investment Analysis"— Presentation transcript:
1FINC4101 Investment Analysis Instructor: Dr. Leng LingTopic: Introduction to Futures
2Learning objectives Define futures contracts. Understand the various features of futures: price, maturity, margins, etc.Describe how futures trading is organized.List the positions of futures contracts.Marking to market.Trading strategies.The payoffs and profits are computed at expiration.
3ForwardsAn agreement between two parties to exchange cash for a commodity or financial asset at some specific time in the future at a predetermined price.Terms are unique to each individual forward contract. That is, each contract is customized.There is a risk that one side might default on its’ obligation.
4ForwardsExample: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.
5FuturesA standardized “forward contract” traded on an organized and regulated futures exchange.Futures contracts are guaranteed by the exchange’s clearinghouse that eliminates the risk of the other party’s default.Each contract is standardized on the quantity, quality, delivery place, delivery date, contract expiration date.A deposit called “margin” is required to both buyers and sellers.
6Standardized Contract Terms Example: a CBOT wheat Futures contractQuantity: 5,000 bushelsCommodity type: No.2 Soft Red, etc.Expiration: July, September, December, March, and MayDelivery place: in a warehouse approved by CBOTMinimum price change (tick size): 0.25 cents per bushel or $12.50 per contract.
7ClearinghouseGuarantees 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.
8Forwards vs. Futures 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.
10Margin and Daily Settlement Initial margin (5-15% of the underlying asset’s value)Maintenance marginMarking 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.Margin Call
11Another 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 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?Q1: contract value x5,000=$17,662.50initial margin x10%= $maintenance margin x5%=$Q2: Loss allowed $loss for each drop in cent x0.01=$50/50= cent= cent/bushelor(x )5000=x= dollarQ3: (x )5000=x= dollar
12Margin and LeverageInitial margin is10%; current oil futures price is $39.48; contract size of 1,000 barrels.Initial margin: 0.1*39.48*1000=$3,948If 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
13Another Example of Marking to Market Example 17.2 (page 552)
14Closing a Position Delivery Offset – reverse trade Cash settlement: make payment at expiration date to settle any gains or losses, instead of making physical delivery.
15Zero Sum Game At maturity date T: Profit to long = PT - original futures priceProfit to short = Original futures price - PT
17Types of Futures Commodities: wheat, oat, cotton Foreign currencies: euro, British pound, Canadian dollar, Japanese yen.Interest-earning assets: Treasury notes and bonds, Eurodollar depositsIndexes: S&P500, Dow Joes, NASDAQ 100Individual stocks, e.g., IBM.
18Participants in Futures Markets Hedgers: hedging, risk managementSpeculators: make money by taking riskBrokers: receive commission feeRegulators: futures exchanges and clearinghouses, the National Futures Association, the Commodity Futures Trading Commission
19Treasury 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 = – Discount Yield
21T-bill Futures Example Jim Sanders purchased a T-bill futures with the price of (a 6% discount) and that the price as of the March settlement date is (a 5.1 % discount). What is the profit from the trade? 94.9%x1,000, %x1,000,000=9,000
22T-bill Futures Example 2 Jim Sanders purchased a T-bill futures with the price of (a 6% discount) and that the price as of the March settlement date is (a 7.5 % discount). What is the profit from the trade? 92.5%x1,000, %x1,000,000=-15,000
23T-Bond Futures (maturity is over 10 years) Treasury Bond Futures (quotation on page 546)Trading cycles: Mar/Jun/Sep/DecQuotations in points and 32nd of par. e.g., ( )Underlying: $100,000 worth (face value) of deliverable T-BondsCash settlement or deliveryTick size is 1/32nd of 0.01 (1/32x0.01x$100,000=$31.25)
24T-bond Futures Example A speculator purchased a futures on Treasury bond at a price of One month later, the speculator sells the same contract at 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
25Interest 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.
26Stock Index Futures Contracts Main stock index futuresSee next slideFeatures:Cash settlementTrading cycle (March, June, September, December)Different contract dollar multipliersQuotations for stock index futures. (Figure 17.1)
28Stock Index Futures Example 1 The spot S&P500 index is 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 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? 1600x x250=$25,000
29Stock 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 …
30Single Stock Futuresa. A contract to buy or sell a single stock (usually 100 shares)b. Settlement dates are quarterlyc. Offer potentially high returns (with high risk)d. Closing out involves taking opposite position anytime before settlement date
31Speculating with Oil Futures Example 17.3 (page 554)
32Hedging with Oil Futures Example 17.5 (page 554)