FINS1612 weekly notes Lect 11.pdf - FINS Week 11 FUTURES...

FINS Week 11 FUTURES CONTRACTS [BKM chp 17]
What is a derivative?
Definition: A derivative is a financial instrument (or simply, an agreement between two people) that
has a value determined by something else
- A bushel of corn: Not a derivative
- An agreement between Tom and Kate: If the price of a bushel of corn
next month is greater than $3, Tom will pay Kate $1;
if the price of corn is less than $3, Kate will pay Tom $1. A derivative
- Derivatives can be dependent on almost anything (e.g., volume of snow falling, price of
commodity and financial assets, temperature)
Basics of Futures/Forward Contract
Arrangement calling for future delivery of asset at agreed-upon price
• Futures/Forward price (Fo)
• Agreed-upon price paid on futures contract at
maturity (T)
• Long position
• Trader who commits to purchasing asset • Short position
• Trader who commits to delivering asset
Key terms for futures contracts
• Long position: agrees to purchase at time T
• Short position: agrees to deliver/sell at time T
• Profits on long and short positions at maturity
• Long = Futures price (spot price) at maturity
minus original futures price
• Short = Original futures price minus futures price (spot price) at maturity
• Zero initial cost (The contract has no value when assigned, but may have value afterwards)
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Comparison between forward and futures contracts
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Samples of Futures Contracts
Source: Bodie, Kane and Marcus (2017: 563)
Volumes By products: futures (2007-2016)
• Source: FIA 2016 annual report
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Futures Trading Mechanics
• Marking to Market
• Maintenance Origin
• Value below which trader’s margin may not fall; triggers margin call
• Convergence Property
Settlement procedures
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