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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
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)
slide2
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
slide3
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
slide4

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
slide5
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.
slide6
Stock Portfolio Short Hedge – On 3/1, a portfolio manager was concerned about the market over the next six months.
  • 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
slide7
2. Hedge Ratio
    • 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
slide8
V. Futures Pricing
    • 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 futures@380 0

T1: deliver gold $380

repay loan (P&I) -$378

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

Cash flows 0 +2

slide9
V. Other Futures & Forwards
    • 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.