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 .
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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.
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The rate of return on risk free bonds is i t . F
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OHCh13 - Chapter 13: Financial Derivatives 1 Forwards and...

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