October 12, Mexico Risk Management Conference Chicago Board of Trade Interest Rate Futures Presented by: Ted Ehret Director of Business Development Chicago Board of Trade

October 12, Futures Market Fundamentals The evolution of the futures market: Cash to forwards to futures contracts Futures pricing: Theory and practice Using futures for investment and risk management purposes Swaps Fed Funds and Binary Options Mexico Risk Management Conference

October 12, Futures Market Fundamentals The evolution of the futures markets 19 th century agriculture –Seasonal delivery of harvest to market created supply and demand imbalances –Transportation and storage problems – Impeded trade flow between east and Midwest

October 12, Futures Market Fundamentals The evolution of the futures markets A temporary solution: Forward contracts –A privately negotiated agreement in which the buyer and seller agree on price, quality, quantity and a future delivery date of the commodity, such as corn, wheat… –Users included farmers, river merchants, grain elevators, processors, millers

October 12, Futures Market Fundamentals The evolution of the futures markets In 1848, 82 merchants gathered above a flour store in Chicago to form the Chicago Board of Trade (CBOT ® ). Promote commerce and provide a centralized marketplace where buyers and sellers could trade

October 12, Futures Market Fundamentals The evolution of the futures markets Drawbacks of forward contracts –Privately negotiated –Not standardized Quality Quantity Delivery place and time –Counter-party Risks Default Bankruptcy

October 12, Futures Market Fundamentals The evolution of the futures markets The Solution: Futures CBOT formalized grain trading in 1865 –Standardized contracts –Centralized exchanges –Price discovery –Clearinghouses Margins

October 12, Interest Rate Margins – Speculative Rates Effective October 9, Maintenance Margin (per contract) Initial Margin Mark Up Percentage Initial Margin (per contract) Treasury Bonds$900135%$1, Year T-Note$600135%$810 5 Year T-Note$400135%$540 2 Year T-Note$350135%$ Day Fed Fund-Tier 1 (Months 1- Month 4) -Less than 21 days to expiration -Less than 14 days to expiration -Less than 7 days to expiration $275 $225 $150 $75 135% 135% 135% $371 $304 $203 $ Day Fed Funds-Tier 2 (Months 5 and later) $375135%$ Year Swaps$675135%$911 5 Year Swaps$400135%$540

October 12, Interest Rate Margins - Hedge Effective October 9, Maintenance Margin (per contract) Initial Margin Mark Up Percentage Initial Margin (per contract) Treasury Bonds$900100%$ Year T-Note$600100%$600 5 Year T-Note$400100%$400 2 Year T-Note$350100%$ Day Fed Fund-Tier 1 (Month 1- Month 4) -Less than 21 days to expiration -Less than 14 days to expiration -Less than 7 days to expiration $275 $225 $150 $75 100% 100% 100% $275 $225 $150 $75 30-Day Fed Fund-Tier 2 (Month 5 and later) $375100%$ Year Swaps$675100%$675 5 Year Swaps$400100%$400

October 12, Interest Rate Margins – Intra-Market Spread Margins Effective October 9, Ratio Spreads - Interest Rates GroupSpread Credit % 3:25 Year T-Notes vs. 10 Year T-Notes90% 3:15 Year T-Notes vs. Treasury Bonds80% 3:22 Year T-Notes vs. 10 Year T-Notes80% 2:110 Year T-Notes vs. Treasury Bonds80% 1:12 Year T-Notes vs. 5 Year T-Notes85% 1:110 Year T-Note Futures vs. 10 Year Swap85% 1:210 Year Swap vs. 5 Year Swap85% 1:15 Year Swap vs. 5 Year Note90% 1:3Treasury Bond vs. 2 Year T-Note75% 1:110 Year T-Note vs. 5Year Swap85%

October 12, Futures Market Fundamentals The evolution of the futures markets Futures Contract: A legally binding agreement to buy or to sell a standardized commodity or financial instrument at some time in the future, at a price agreed upon today and traded on an organized and regulated futures exchange.

October 12, Futures Market Fundamentals The evolution of the futures markets Clear understanding of contract performance Contract is clearly defined Balanced transaction –No bias toward either side of the transaction Broad cross section of buyers and sellers Good exchange environment and support Price is the only element that is subject to negotiation Important Features For A Successful Futures Contract

October 12, Futures Market Fundamentals Futures pricing: Theory and practice

October 12, Futures Market Fundamentals: Futures pricing: Theory and practice 2 Year US Treasury Notes Futures 5 Year US Treasury Notes Futures 10 Year US Treasury Notes Futures 30 Year US Treasury Notes Futures CBOT US Treasury Futures Complex

October 12, Futures Market Fundamentals: Futures pricing: Theory and practice Average Daily Volume Notional Value (US$ Billions) Month-End Open Interest Notional Value (US$ Billions) 2-Year Note148,167$ ,609$ Year Note502,258$50.21,402,786$ Year Note1,002,582$100.32,217,489$221.8 Bond380,692$ ,035$77.8 2,033,699$218.25,097,919$579.8 As of September 30, 2006

October 12, Futures Market Fundamentals: Futures pricing: Theory and practice Treasury futures contracts are based on a 6% coupon There are several issues that are deliverable into a Treasury futures contract Treasury futures prices track the “cheapest to deliver” security, the single instrument that generally stands out as the “cheapest” or most economical to deliver--which may not be a 6% instrument

October 12, Futures Market Fundamentals Futures pricing: Theory and practice Example: 10 Year US Treasury Note Futures Contract

October 12, Futures Market Fundamentals: Futures pricing: Theory and practice Example: 10 Year US Treasury Note Futures Other standardized futures contract terms include:

October 12, Futures Market Fundamentals: Futures Pricing: Theory and practice Cash - Futures Relationship Futures contracts are a good proxy for the cash instruments because cash and futures prices generally highly correlated because both are affected by the same economic factors.

October 12, Futures Market Fundamentals: Futures pricing: Theory and practice Basis The difference between the current cash price and the futures price of the same commodity. Basis = Cash Price - (Futures Price x Conversion factor)

October 12, Futures Market Fundamentals: Futures pricing: Theory and practice Cost of Carry Reflects the net cost of financing or “carrying” the instrument, i.e., buying, financing and holding it until delivery Factors affecting cost of carry will vary by instrument

October 12, Futures Market Fundamentals: Futures pricing: Theory and practice Convergence As time to delivery approaches, the market price and futures prices “converge” Convergence reflects the decay in the cost of carry During delivery months, the basis narrows and should approach zero

October 12, Futures Market Fundamentals: Futures pricing: Theory and practice Cash Price Sep Futures Price Convergence JanMarSep Cost of Carry

October 12, Futures Market Fundamentals: Futures pricing: Theory and practice Delivery Exchange of the actual underlying commodity or financial instrument to settle the obligations of the futures contract – The potential for delivery influences the cash-futures price relationship – Futures contracts can be either physical delivery or cash - settled

October 12, Futures Market Fundamentals: Futures pricing: Theory and practice Cash SettledPhysical Delivery Today:Buy or sell contractBuy or sell contractat today’s futuresprice. Daily:Pay losses/collectPay losses/collectprofits on pricedifference fromyesterday’s closingprice.

October 12, Futures Market Fundamentals: Futures pricing: Theory and practice Cash SettledPhysical Delivery Settlement:Contract expires,If position not offset, no further mark-to-buyers must accept market paymentsdelivery at the invoice or receipts price; sellers must deliver instrument at the invoice price

October 12, Futures Market Fundamentals: Futures pricing: Theory and practice The conversion factor is the approximate price, in decimals, at which the note or bond would trade if it yielded 6% to maturity (rounded to whole quarters) 1. To calculate a cash equivalent forward price — that is, to convert a futures price to an approximation of the forward price of a given deliverable Treasury security — you can multiply the futures price by the conversion factor for that security. 1 Galen D. Burghardt at al., The Treasury Bond Basis, Third Edition (McGraw-Hill, 2005), p. 6.

October 12, Futures Market Fundamentals: Futures pricing: Theory and practice Characteristics of Conversion Factors: –Unique to each bond and delivery month –Constant throughout the delivery cycle –If the coupon is greater than 6%, then the conversion factor is greater than 1. If the coupon is less than 6%, then the conversion factor is less than 1 2 –Used to calculate invoice prices –Sometimes used as a hedge ratio 2 Ibid., pp.6-7.

October 12, Futures Market Fundamentals: Futures pricing: Theory and practice

October 12, Futures Market Fundamentals: Futures pricing: Theory and practice For example, consider a 5 1/8% coupon note with nine years and seven months remaining to maturity, which is deliverable into the nearby 10-year Treasury note futures contract: –Futures Price: ( ) –Conversion Factor: –Futures price * Conversion Factor = Cash Equivalent * = ( )

October 12, Futures Market Fundamentals Using futures for investment and risk management purposes

October 12, Futures Market Fundamentals: Using futures for investment and risk management purposes Speculating Seeking to profit from buying and selling futures by anticipating future price movements. –Speculators assume the price risk that hedgers seek to reduce. –Speculators add liquidity and capital to the futures markets.

October 12, Futures Market Fundamentals: Using futures for investment and risk management purposes Hedging Initiation of a position in the futures market that is intended as a temporary substitute for the purchase or sale of the actual commodity at a later date.

October 12, Futures Market Fundamentals: Using futures for investment and risk management purposes To Hedge With Financial Futures: Choose the contract that most closely describes the nature of the underlying risk Choose the expiration month that most closely matches the time period to be addressed Buy or sell the appropriate number of futures contracts to cover your exposure

October 12, Futures Market Fundamentals: Using futures for investment and risk management purposes Hedging Sell (or go short) futures: to protect against exposure to falling prices or rising rates to preserve portfolio value by locking in a selling price

October 12, A Short Hedge If the firm has an inherent long position (i.e., is already holding the commodity or instrument)... V P long cash position

Dollar Value of a Basis Point (DV01) Change in dollar price of security for one basis point change in yield Larger (smaller) DV01s indicate larger (smaller) price volatility Hedging the On-The-Run 10-year 37

October 12, Goal: Hedge your position by selling enough 10-year Treasury futures that will almost exactly offset the change in your cash Treasury note position Find the Right Number of Futures Contracts –divide the DV01 of your actual Treasury position by the futures DV01 to arrive at the hedge ratio. The DV01 of the futures is driven by the cheapest-to- deliver security in the basket 4 ¼ % 8/2013. Hedging the On-The-Run 10-year

October 12, Hedging the On-The-Run 10-year

October 12, Hedging the On-The-Run 10-year

October 12, Hedging the On-The-Run 10-year

October 12, Hedging the On-The-Run 10-year Calculating the DV01 of the Futures contract Futures DV01 = CTD DVO1/CTD Conversion Factor = / =

October 12, Hedging the On-The-Run 10-year Hedge Ratio = Portfolio DV01/Futures DV01 = 7.879/ = 125 contracts

October 12, Hedging the On-The-Run 10-year

October 12, Hedging the On-The-Run 10-year

October 12, Hedging the On-The-Run 10-year

October 12, Hedging the On-The-Run 10-year

48 Caveats on Hedging Futures hedges are imperfect. Hedging effectiveness impacted by unexpected changes: Value of strategic delivery options. Term financing rates. Slope of deliverable yield curve. Credit of cash market position. Manage your position.

To learn more buy The Treasury Bond Basis: An In- Depth Analysis for Hedgers, Speculators, and Arbitrageurs Galen Burghardt, Terrence Belton, Morton Lane, and John Papa, McGraw-Hill, Third Edition, 2005 Visit 49

Interest Rate Swap Futures

October 12, Futures Market Fundamentals: Interest Rate Swap Futures CBOT Swap futures employ an internal rate of return formula to express the fixed rate of a forward-starting swap as the price of a 6% coupon note. The underlying contract reference is the rate for a forward-starting IMM-date interest rate swap – specifically, the par rate for a plain vanilla interest rate swap with forward start date on the third Wednesday (“IMM Wednesday”) of the futures contract’s expiration month.

October 12, Futures Market Fundamentals: Interest Rate Swap Futures Contract specifications call for each contract to be cash settled with reference to the pertinent ISDA (International Swaps and Derivatives Association, Inc.) Benchmark Rate on the last day of trading. ISDA Benchmark mid-market par swap rates are collected at 11:00 a.m. New York time by Reuters Limited and Garban Intercapital plc and are published on Reuters page ISDAFIX3. (Source: Reuters Limited.) Daily publication occurs around 11:30 a.m. New York time.

October 12, Futures Market Fundamentals: Interest Rate Swap Futures The $100,000 nominal size of each contract signifies the notional par value of an interest rate swap that exchanges semiannual fixed-rate payments for floating- rate payments. The fixed payments are based on a 6% annual rate, and the floating payments are based on 3-month LIBOR (London Interbank Offered Rate).

October 12, Futures Market Fundamentals: Interest Rate Swap Futures Swap futures trade in price terms and are quoted in points ($1,000 per one point), 32nds of points ($31.25 per one 32nd), and halves of 32nds of points ($15.625). As with CBOT U.S. Treasury Note and Bond futures, the expiration cycle for Swap futures is March, June, September, and December.

October 12, Key Benefits: It’s a futures contract –Standardization A Swap futures contract transforms its underlying reference swap rate into an index number that essentially looks and behaves like the price of a 6% coupon note. The mapping from the par swap rate to the contract price is standardized and one-to-one. So is the mapping from the par swap rate to key characteristics of the contract’s price behavior, including: –Interest rate sensitivity of price (i.e., the contract’s DV01change in the underlying forward swap rate) and –Convexity of the contract price with respect to the underlying forward swap rate. By creating such standardization, CBOT Swap futures offer market participants a convenient device for gauging the relative utility and effectiveness of alternative positions and strategies. Futures Market Fundamentals: Interest Rate Swap Futures

October 12, Key Benefits: It’s a futures contract –Position Scalability –Trade Scalability –Administrative Convenience and Low Operational Cost –Transparency –High-Grade Credit Exposure –Capital Efficiency –Off-Exchange Trading Futures Market Fundamentals: Interest Rate Swap Futures

October 12, Key Benefits –Off-Exchange Trading Exchange-For-Physical (EFP) Exchange-For-Swap (EFS) Exchange-For-Risk (EFR) Wholesale Futures Market Fundamentals: Interest Rate Swap Futures

October 12, Futures Market Fundamentals: Interest Rate Swap Futures Data Sources: Chicago Board of Trade, International Swaps and Derivatives Association CBOT 10-Year Swap Futures and OTC 10-Year Swaps Correlations of (a) daily changes in forward-starting swap rates implied by prices of nearby CBOT 10-Year Interest Rate Swap futures with (b) daily changes in ISDA Benchmark Rates for OTC spot 10-year interest rate swaps.

October 12, Futures Market Fundamentals: Interest Rate Swap Futures CBOT 5-Year Swap Futures and OTC Spot 5-Year Swaps Correlations of (a) daily changes in forward-starting swap rates implied by prices of nearby CBOT 5-Year Interest Rate Swap futures with (b) daily changes in ISDA Benchmark Rates for OTC spot 5-year interest rate swaps. Data Sources: Chicago Board of Trade, International Swaps and Derivatives Association

October 12, Liquidity Futures Market Fundamentals: Interest Rate Swap Futures June 6, 2006 – The Chicago Board of Trade (CBOT ® ) announced that Citigroup and Goldman Sachs & Co. will join the existing market maker and provide liquidity to all market participants in CBOT 5-Year and 10-Year Swap futures beginning in July 2006.

October 12, Futures Market Fundamentals: Interest Rate Swap Futures Swap Futures Contract SizeMinimum Bid/Ask Spread Customary Bid/Ask Spread 5-Year$200 Mln Notional 2,000 Contracts Approx 0.7 bps 1/32 nd Approx 0.35 bps 0.5/32 nds 10-Year$200 Mln Notional 2,000 Contracts Approx 0.6 bps 1.5/32 nds Approx 0.4 bps 1/32 nd

October 12, Futures Market Fundamentals: Interest Rate Swap Futures

October 12, Federal Funds Futures and Binary Options on the Target Federal Funds Rate

October 12, Futures Market Fundamentals: Federal Funds 30 Day Fed Fund Futures Contract Size $5 million Tick Size $ per 1/2 of one basis point (1/2 of 1/100 of one percent of $5 million on a 30-day basis rounded up to the nearest cent). Price Quote 100 minus the average daily fed funds overnight rate for the delivery month (e.g. a 7.25 percent rate equals 92.75) Contract Months First 24 calendar months Last Trading Day Last business day of the delivery month. Trading in expiring contracts closes at 2:00 pm, Chicago time on the last trading day. Settlement The contract is cash settled against the average daily fed funds overnight rate, rounded to the nearest one-tenth of one basis point, for the delivery month. The daily fed funds overnight rate is calculated and reported by the Federal Reserve Bank of New York. Trading Hours Open Auction: 7:20 am - 2:00 pm, Central Time, Monday - Friday Electronic: 6:01 pm - 4:00 pm, Central Time, Sunday – Friday Ticker Symbols Open Auction: FF Electronic: ZQ Daily Price Limit N/A Margin Information Find information on margins requirements for the 30 Day Fed Fund Futures.margins requirements

October 12, Futures Market Fundamentals: Federal Funds To protect against the anticipated lowering of the fed funds target rate, you can buy CBOT fed funds futures sufficient to essentially offset a loss of that magnitude. The first task in structuring such a hedge is to determine the appropriate number of futures contracts to use. To hedge a US $1 billion portfolio against a lower Fed Funds rate Hedge ratio = Actual number of days in a month X $ amount hedged 30 $5 million Buy 200 contracts

October 12, Futures Market Fundamentals: Federal Funds Using Fed Funds Futures to forecast Federal Funds Target Rate –FF futures implied rate = target x db/d + [ (target+0.25) x p + target x (1-p) ] x da/d Target is the current target fed funds rate. p is the probability that the FOMC will raise the target rate 25 bps and (1-p) is the probability that it will leave the target unchanged. db is the number of days in the month for which the current level of the target rate applies, i.e., the number of days before and including the FOMC meeting date. da indicates the number of days in the month for which the FOMC’s next setting of the target rate will apply, i.e., the number of days in the month after the FOMC meeting date. d is the total number of days in the month. Note that d = db + da

October 12, Futures Market Fundamentals: Federal Funds Let’s emphasize that this is an approximation, insofar as it takes the rate implied by the FF futures contract price (i.e., 100 minus rate) as an unbiased estimate of the target fed funds rate. In fact, the rate that enters into the valuation of the FF futures contract is not the target fed funds rate, but rather the effective fed funds rate. The effective fed funds rate seldom equals the target rate. Indeed, the gap between the two – the Diff – is frequently several basis points.

October 12, Futures Market Fundamentals: Federal Funds 30 Day Federal Funds Futures Settlement Price –The contract is cash settled against the average effective overnight fed funds rate, rounded to the nearest one-tenth of one basis point, for the delivery month. The daily effective fed funds rate is calculated and reported by the Federal Reserve Bank of New York. The monthly average is understood to include non-business days (weekends and holidays); the rate that applies to any non-business day is the effective overnight fed funds rate for the preceding business day.

69 The ‘BIG’ Picture FF and FFO price dynamics are measured in the familiar price value of a basis point (PV01), whereas Binary price dynamics are gauged in terms of price value of probability points (PVP). Futures Market Fundamentals: Federal Funds

70 Big Picture: Target FFR and Overnight Rates Futures Market Fundamentals: Federal Funds

CBOT Binary Options on the Target Federal Funds Rate are so called because they offer only two outcomes. Depending on the level of the target fed funds rate at option expiry: Option owner either receives $1000 or $0. Option seller either pays $1000 or $0. Futures Market Fundamentals: Federal Funds

72 Option Payouts: Conventional vs. Binary Futures Market Fundamentals: Federal Funds

October 12, Binary Options Specs Description CBOT Binary Options on the Target Federal Funds Rate are contracts that have fixed payouts based upon the relationship between the option strike price and the target fed funds rate (quoted in 100-minus-rate terms), as set by the Federal Open Market Committee (FOMC). With Binary Options there is a defined risk and reward for both the buyer and the seller: there is a payout of $1,000 (the buyer receives and the seller pays) if the option expires in-the-money, and $0 if it does not. Price Basis Par is on the basis of 100 points, with one point equal to $10. The price is never less than zero points or greater than 100 points. Minimum Price Fluctuation One point, equal to $10. Delivery Months Customarily, options shall be listed for expiration in each of the next four delivery months. An option’s delivery month shall be determined by the concluding day of the regularly scheduled FOMC meeting that the option references, as shown in the FOMC meeting calendar at the time the option is listed for trading. The FOMC meeting calendar is maintained and published by the Board of Governors of the Federal Reserve at Futures Market Fundamentals: Federal Funds

October 12, Futures Market Fundamentals: Federal Funds Last Trading Day An option’s last trading day shall be fixed when the option is listed for trading, and shall be based upon the FOMC meeting calendar at the time the option is listed for trading. For the September, 2006 option the last trading day is September 20, 2006; for the October, 2006 option the last trading day is October 24, 2006; and for the December, 2006 option the last trading day is December 12, For any option expiring in January 2007 or later, the last trading day will be business day following the concluding day of the FOMC meeting that the option references. Trading Hours 6:00 p.m. to 4:00 p.m., Chicago time, Sunday through Friday. Trading in an expiring option shall cease at 3:00 p.m. Eastern time (2:00 p.m. Chicago time) on the last trading day..Strike Levels Option strikes shall bracket the prevailing target fed funds rate (expressed in 100-minus-rate terms). For newly-listed delivery months, strikes shall be listed in increments of 12.5 basis points, at the prevailing target plus twenty (20) consecutively higher and (20) consecutively lower strikes, subject to the constraint that strikes can never be less than 0.00 nor greater than

October 12, Settlement An expiring option shall be cash settled with reference to the target fed funds rate (expressed in 100-minus-rate terms) that is in effect as of 6:00 p.m. Eastern time on the option’s last trading day. Customarily (though not always) this will be the outcome of the regularly scheduled FOMC meeting that the option references. The target fed funds rate shall be as found in the most recently published Statement of the FOMC, typically published immediately following adjournment of any FOMC meeting. (See )For any binary put option with a strike greater than the target fed funds rate (expressed in 100-minus- rate terms) on the option’s last trading day, long position holders shall receive, and short position holders shall pay, $1,000. For any binary put option with a strike equal to or less than the target fed funds rate on the option’s last trading day, longs shall receive, and shorts shall pay, $0.For any binary call option with a strike less than the target fed funds rate (expressed in 100-minus-rate terms) on the option’s last trading day, long position holders shall receive, and short position holders shall pay, $1,000. For any binary call option with a strike equal to or greater than the target fed funds rate on the option’s last trading day, longs shall receive, and shorts shall pay, $0.All final pays and collects shall be made on the business day following the determination of the final settlement prices of the expiring binary options. Trading Platform Electronic Matching Algorithm Pro-rata with preferencing and priority orders (minimum of 25 contracts, maximum of 250 contracts) Ticker Symbol Calls: BUSC, Puts: BUSP Futures Market Fundamentals: Federal Funds

October 12, Appendix

October 12, Futures Market Fundamentals: Using futures for investment and risk management purposes Hedging Buy (or go long) futures: to protect against exposure to rising prices or falling rates to limit opportunity loss by locking in a purchase price

October 12, A Long Hedge If the firm has an inherent short position (i.e., is planning to purchase or acquire the security)... V P short cash position

October 12, A Long Hedge The long hedge is created by buying the appropriate number of futures to neutralize the exposure V P long futures position short cash position

October 12, Futures Market Fundamentals: Using futures for investment and risk management purposes Goal: To protect your purchasing power when you fear yields may drop Pop Quiz: What do you do?

October 12, Futures Market Fundamentals: Using futures for investment and risk management purposes Other Applications for Institutional Investors Asset Allocation or Portfolio Rebalancing Duration Adjustments “Securitizing” Cash Investing Funds During a Search Gaining Exposure to a Market in Anticipation of an Inflow of Funds

October 12, Futures Market Fundamentals: Using futures for investment and risk management purposes Asset Allocation –Enforce the mix of assets as set forth in your fund's policy. –Perform a temporary reallocation to take advantage of current attractive market conditions.

October 12, Futures Market Fundamentals: Using futures for investment and risk management purposes Asset Allocation Scenario: Suppose your pension fund’s assets are divided between $400 million in stocks and $100 million in bonds (80%/20%). Your fund’s policy calls for a mix of 60% stock and 40% bonds, so in order to maintain your allocation strategy, $100 million in stocks must be sold and $100 million in bonds must be purchased.

October 12, Futures Market Fundamentals: Using futures for investment and risk management purposes Asset Allocation Strategy: Use futures to enforce your allocation policy by buying T- bond futures and selling CBOT ®DJIA stock index futures. This will allow your manager the time to select and purchase/sell the actual securities he desires.

October 12, Futures Market Fundamentals: Using futures for investment and risk management purposes Securitizing Cash –Allows you to quickly get exposure to a particular market at times when your managers may be holding too much cash. –Gives you time to select which markets you want to be in and also lessens the impact on the market, resulting in a better price.

October 12, Futures Market Fundamentals: Using futures for investment and risk management purposes Securitizing Cash Scenario: Your fund is required to be fully invested with no more than 5% allocated to cash at any one time. You recently received a $25 million cash inflow which you are therefore obligated to invest as quickly as possible. However, the size of the position you need could result in an increase in the asking price of the securities you are seeking.

October 12, Futures Market Fundamentals: Using futures for investment and risk management purposes Securitizing Cash Strategy: Buy futures to quickly and efficiently gain exposure to the desired market--either fixed income or equities. Then, you gradually invest the cash over a period of several days while simultaneously unwinding your futures position by selling the same number of contracts you bought.

October 12, Futures Market Fundamentals: Using futures for investment and risk management purposes How Futures Make Risk and Investment Management More Efficient Do not upset portfolio or change allocation on a permanent basis. Do not disrupt the activities of external managers. Greater liquidity means decisions can be implemented more quickly and cost-effectively than in the cash market. Allow time to select the securities to involve in the asset allocation process. Allow you to quickly react to significant events.

89 CBOT ® Disclaimer The information herein is taken from sources believed to be reliable. However, it is intended for purposes of information and education only and is not guaranteed by the Chicago Board of Trade as to its accuracy, completeness, nor any trading result and does not constitute trading advice or constitute a solicitation of the purchase or sale of any futures or options. The Rules and Regulations of the Chicago Board of Trade should be consulted as the authoritative source on all current contract specifications and regulations. ©2006 Chicago Board of Trade. All rights reserved.

October 12, The Fundamentals of Exchange-Traded Derivatives Futures Market Fundamentals Presented by: Ted Ehret Director of Business Development Chicago Board of Trade