# OHCh13 - Chapter 13 Financial Derivatives 1 Forwards and...

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Chapter 13: Financial Derivatives

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1 Forwards and Futures Futures contracts are traded in exchanges. Forward contracts are agreements by two parties. These specify the price and quantity a transaction to be carried out at In contrast, a transaction which occurs immediately is called a spot trans- action. A trader who purchases a security (or commodity) in a futures contract is said to have a long position . A trader who sells a security (or commodity) in a futures contract is said to have a short position .
1.1 Three Functions of Futures Contracts transactions: arbitrage, speculation, and hedging. 1.1.1 Arbitrage using a di±erence in prices of securities of essentially the same assets. Example: spot and futures markets for gold.

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The price of gold in the spot market is referred to as the spot price . Suppose that the spot price S t of gold is \$400 per ounce today at t . In the futures market at t , suppose that the the price of gold to be delivered in one year ( F t ) is \$440 per ounce. If the one year interest rate i t is 8 t , he borrows \$400, buys one ounce of gold in the spot market, and sells one ounce of gold in the futures market to be delivered in one year. In one year, at time t +1, he delivers once ounce of gold, receives \$440, and pays back \$400(1 + i t )) = \$432. He obtains \$8 without any risk at t + 1. In this example, there are two assets which are essentially the same. One asset is gold and the other asset is a risk free bond. In terms of dollars, the rate of return on gold is ( F t =S t ) 1.
The rate of return on risk free bonds is i t . F

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## This note was uploaded on 07/17/2008 for the course ECON 520 taught by Professor Ogaki during the Spring '07 term at Ohio State.

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OHCh13 - Chapter 13 Financial Derivatives 1 Forwards and...

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