Getting Into and Out of Futures Contracts BA 543 Xinwei WU 05/18/2011
Agenda • What’s Futures Contracts? • Differences between Futures and Forward • Clearinghouse for Futures • Important Basics of Futures • Economic Functions • Margin Requirements • Financial Futures
What’s Futures Contract? • An agreement made today regarding the terms of a trade that will take place later. • Financial futures (i.e. S&P 500, T-bonds, foreign currencies, interest rate and other.) • Commodity futures ( i.e. wheat, crude oil, cattle etc.)
Clearinghouse • Function - Guarantee transaction will perform - Make unwinding positions prior simple • Major Exchanges: 1848 Chicago Board of Trade (CBOT) 1872 New York Mercantile Exchange 1874 Chicago Mercantile Exchange 1882 Kansas City Board of Trade CBOT, NYMEX and CME have merged to be the CME group.
Basics of Futures Contracts • Five Key Elements: Underlying Asset Contract Size Maturity/Expiration Date Delivery/Settlement Type: Physical & Financial Future Price • Long (buy) Futures & Short (sell) Futures: Like stocks • Liquidity - Two choices: Liquidated prior to the settlement date & Wait until the settlement date - Measure: The # of contracts that have been entered into but not yet liquidated.
Basic Economic Functions • Futures contracts provide an opportunity for market participants to hedge against the risk of adverse price movements. (Hedgers transfer price risk.) • Futures contracts are also used for speculation. (Speculators absorb price risk.)
Hedging Example – Corn Futures • Farmer has 10,000 bushels of corn to sell in Dec. • Cost of plant and harvest = $6.2/bushel • What happens without or with hedging?
Margins Requirements • Futures, just like stocks, are traded only by exchange members (Firms, Individuals, or brokerage firms.) • Initial Margin - Required when futures position is established - Depend on the price of underlying assets and type of trader
Margins Requirements Maintenance Margin • The futures exchange adds or subtracts your money from initial deposit of trading account daily when the price changes. • If the balance of trading account too low, the exchange issues a margin call. Deposit more money • Futures position can be closed at any time.
Margin Example - Gold Futures • Go long 10 Aug 2011 Gold Futures • Initial Margin = 6751/contract • Maintenance Margin = 5001/contract
Financial Futures • More efficient means for investors to alter their risk exposure to an asset. • Tie together with cash market.
Financial Futures • Stock Index Futures • Single Stock Futures • Narrow-Based Stock Indexes • Interest Rate Futures • Eurodollar Futures • Federal Funds Futures • Treasury Bill Futures • Treasury Bond Futures • Treasury Note Futures
Example:10 yr US Treasury Note Futures • Underlying Asset: 10 yr US Treasury Note • Contract Size: One US Treasury note having a face value at maturity of $100,000 • Maturity Date: Sep 2011(Last business day of Sep.) • Settlement Type: Federal Reserve book-entry wire-transfer system • Price Unit: 121’190 Points ($1,000) and halves of 1/32 of a point. Par is on the basis of 100 points • Value of 1 Sep 2011 Contracts = 121’190%*$100,000 = 121(19/32)%*$100,000 =$118,593.75
Future Contract • In early history, only agricultural commodities were traded in these exchanges (i.e. corn, wheat.) • Today, agricultural futures still play an important role in futures exchanges. • On the other hand, financial futures are also important and successful.
Sources • Wikipedia • CME Group http://www.cmegroup.com/
Questions? • Topic: Getting into and out of Futures Contracts • Presenter: Xinwei WU