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Futures Markets. I. The Development of Futures Markets 1. Chicago Board of Trade (1848) – grain 2. Chicago Mercantile Exchange (1898) – merge of Chicago Produce Exchange & Chicago Butter & Egg Board 3. Financial Futures A. Foreign Currency Futures (1972) B. GNMA Futures (1975)

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Futures Markets

  • I. The Development of Futures Markets

    • 1. Chicago Board of Trade (1848) – grain

    • 2. Chicago Mercantile Exchange (1898) – merge of Chicago Produce Exchange & Chicago Butter & Egg Board

    • 3. Financial Futures

      • A. Foreign Currency Futures (1972)

      • B. GNMA Futures (1975)

      • C. T-Bill Futures (1976)

      • D. T-Bond Futures (1977)

      • E. Eurodollar Futures (1981)

      • S&P500 Index Futures (1982)

      • Dow-Jones Index Futures (1997)


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  • II. Futures Contracts

    • 1. Forward Contract vs. Futures Contract

    • 2. Basics of Futures Contract

      • Types of Futures

        • Grains & Oilseeds

        • Livestock & Meat

        • Food and Fiber

        • Metals & Energy

        • Financials & others

      • Quotations

      • (Bonds)

      • (Contract Specifications)

  • III. Mechanics of Trading

    • 1. Trading Pits vs. GLOBEX

    • 2. The Clearing House


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  • 3. Marking to Market

    • Initial Margin & Maintenance Margin (Performance Bond)

    • Daily Settlement

      • Example

    • Cash Deliver vs. Actual Delivery

      • Actual delivery: less than 1%

      • Cash delivery: stock index futures

    • Regulations

      • CFTC: Commodity Futures Trading Commissions

      • Price Limit (e.g., silver @ $1/per day)

  • IV. Futures Market Strategies

    • 1. Hedging

      • Short Hedge

        • Long cash, short futures


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    • Long Hedge

      • short cash, long futures

    • Examples

    • - If you own an asset

    • - If you plan to sell an asset

    • - If you are short an asset

    • - If you are committed to buying an asset in the future

    • - If you have issued a floating rate liability

    • - If you plan to issue a liability


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    • Bond Portfolio _____ Hedge

    • A long-term bond portfolio manager forecasts that interest rate will increase over the next few months. The manager holds a portfolio of $1 million face value, 11-7/8s, 2023 corporate bond.


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    • On 3/1, the SP500 index futures was @1,190, the manager shorted 5 contracts {[1,285,700/ (1,190 x 250)]=4.3}

    • On 9/2, SP500 index futures is @ 1,218, the manager longs 5 contracts .

    • Loss in the futures: (1,218-1,190) x250 x 5 = 35,000


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    • 2. Hedge Ratio was concerned about the market over the next six months.

      • Naïve hedge ratio

      • Minimum variance hedge ratio

        • Run a linear regression line S =  +  F, where  is the minimum variance hedge ratio

        • # of futures contract: N =  (S/F)

    • 3. Which futures commodity?

      • Cross Hedge – choose the one that has high correlation between futures price and underlying asset price

    • 4. Which Expiration?

      • Choose a future with expiration month close to but after the hedge terminates

      • Deferred contract may have liquidity problem


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    • V. Futures Pricing was concerned about the market over the next six months.

      • Spot-Futures Parity (Cost of Carry Model)

      • 1. F0 = S0 (1+r)T

        • Example: F0 = 360(1.05)1 = 378

      • 2. Arbitrage occurs when the equilibrium relation is violated (e.g., F0 = 380)

        • Example

          T0T1 .

          T0: borrow $360 $360

          buy gold -$360

          short [email protected] 0

          T1: deliver gold $380

          repay loan (P&I) -$378

          ----------------------------------------------------------------------

          Cash flows 0 +2


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    • V. Other Futures & Forwards was concerned about the market over the next six months.

      • 1. Options on Futures

      • 2. Hedging with Foreign Currency Forwards

        • Scenario: On June 1, a multinational firm with a British subsidiary decides it will need to transfer £10 million from an account in London to an account with a NY bank. Transfer will be made on September 6. The firm is concerned that pound will weaken.

    • Analysis: The £ end up worth $13,570,000 – 12,375,000 = $1,195,000 less but are delivered on the forward contract for $13,570,000, thus eliminating the risk.


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