Chapter 26 futures markets
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Chapter 26 – Futures Markets. Forward Contracts A contract that two parties agree to today such that both parties are obligated to complete a transaction in the future Price set for transaction Delivery Date set for transaction Commodity set for transaction

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Chapter 26 – Futures Markets

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Chapter 26 futures markets

Chapter 26 – Futures Markets

  • Forward Contracts

    • A contract that two parties agree to today such that both parties are obligated to complete a transaction in the future

      • Price set for transaction

      • Delivery Date set for transaction

      • Commodity set for transaction

      • Delivery Location set for transaction

    • Examples

      • Hotel Reservation, Airplane Ticket, Book Order


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Chapter 26 – Futures Markets

  • Futures Contracts

    • Just like forward contract except

      • Traded on an Organized Exchange

      • No money changes hands between the two parties today

    • Terms Matching

      • Commodity to be delivered or received is the UNDERLYING

      • Price for transaction is the FUTURES PRICE

      • Delivery Date is the SETTLEMENT DATE


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Chapter 26 – Futures Markets

  • Parties in the Futures Contract

    • Buyer of the Futures Contract is “buying or taking delivery of the commodity” in the future and is said to be LONG in the contract

    • Seller of the Futures Contract is “selling or making delivery of the commodity” in the future and is said to be SHORT in the contract

    • The Exchange where the futures contracts are bought and sold

    • Clearing House guarantees performance


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Chapter 26 – Futures Markets

  • Example of a Forward Contract and the Parties Economic Incentives

    • Order a Book for Future Delivery

    • Parties

      • Buyer of the Book

      • Bookstore

    • Contract

      • Commodity Book

      • Delivery Date (Three Weeks)

      • Price $15.00


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Chapter 26 – Futures Markets

  • Example Continued

    • During the 3 Week period

      • Buyer sees “ordered” book at Borders for $12.50

      • Buyer “skips” out of contract (fails to perform) and buys book at Borders saving $2.50

      • Bookstore has book and no buyer

    • During the 3 Week period

      • Bookstore sees book selling on eBay for $19.00

      • Bookstore “skips” out of contract and sells book on eBay for $19.00 making an extra $4

      • Buyer of contract still waiting for book


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Chapter 26 – Futures Markets

  • Closer Look at the Contracts

    • Futures Price and Spot Price and Settle Price

      • Futures price is the contract agreed to price and varies through out the life of the contract as different parties “reach” different agreements

      • Spot price is the current market price for delivery and exchange of the commodity

      • Settle Price is the consensus price of the contract at the end of the trading day

    • Difference between YOUR contract futures price and the consensus end of day price each day reflects profit or loss on the contract


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Chapter 26 – Futures Markets

  • An example of an Actual Contract

    • Wheat Futures at the Kansas City Board of Trade

      • Size of Contract is 5,000 bushels

      • Commodity is Hard Red Winter Wheat

      • Delivery is at Grain Storage Facility on the Missouri River near the Railroad Shipping Yards

      • Price stated in cents per bushel, 280

    • What does this mean?

      • Buyer Position and Seller Position of one contract


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Chapter 26 – Futures Markets

  • Who are the traders involved in the contracts?

    • Originator of the contract

      • Hedgers and Speculators

        • Hedgers for Insurance (against future price movements)

        • Speculators betting on a price movement in their favor

      • Market Makers

        • Dealers trading for customers

        • Locals


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Chapter 26 – Futures Markets

  • Profits and Losses

    • Zero Sum Game

      • For every dollar one party makes the party on the opposite side of the contract loses a dollar

      • Rising prices profit to buyer of the contract

      • Falling prices profit to seller of the contract

      • Hedgers always break even when considering their inventory position

    • Diagrams of Payoffs for Futures


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Chapter 26 – Futures Markets

  • Getting In and Out of Contracts

    • Complete the contract (make or take delivery and pay or receive futures price)

    • Sell or Buy opposite position before delivery date

    • How can new buyer/seller be matched?

    • How can Clearing House guaranteeing the Performance of the buyer and seller?

    • MARGINS and Marking to Market


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Chapter 26 – Futures Markets

  • Financial Futures

    • Settlement in Cash

    • Contracts traded against “fictitious” underlying

  • Questions on the Soundness of Trading Financial Futures – GAO Study

  • Governing the Futures Markets

    • Self Regulating Organizations

    • CFTC – Commodity Futures Trading Commission


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Chapter 26 – Futures Markets

  • What happens to the Hedger when the inventories are short of the required delivery of the contract

    • Buying in the Spot

    • Delivery in the Spot and Close Futures Position

    • Gains or Losses from the different strategies

  • Forward Rate Agreements

    • Special Futures – i.e. a Forward Contract


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