chap04aem421 - Jarrow, Turnbull, Chatterjea Forward and...

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© Jarrow, Turnbull, Chatterjea Forward and Futures Contracts and Their Markets Chapter 4 Page 1 AEM 421, Fall Chapter 4 Forward and Futures Contracts and Their Markets 4.1 Introduction 4.2 Comparison of a Forward and a Futures 4.3 Applications and Uses of Forward and Futures 4.4 A Brief History of Forward and Futures Early Trading of Forward Contracts U.S. Futures Exchanges and the Evolution of the Modern Futures Contract, 1848-1925 Recent Developments, 1970 Onwards Variety of contracts New exchanges Consolidation and linkages Automation of trading 4.5 Futures Contract Features and Price Quotes U.S. Commodity and Financial Futures Contracts Gold Futures Contract Characteristics Gold Futures Price Quotes 4.6 Regulation of U.S. Futures Market CFTC, NFA, and the Regulatory Role of Exchanges Margins and Daily settlement Clearinghouses Trading Process Market Manipulation Stories 4.7 Summary 4.8 Further Information, References, Questions and Problems Information References Questions and Problems
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© Jarrow, Turnbull, Chatterjea Forward and Futures Contracts and Their Markets Chapter 4 Page 2 AEM 421, Fall 4.1 Introduction The Book of Genesis in the Old Testament tells an interesting story. An Egyptian Pharaoh saw in his dreams that there were seven fat cows, which were followed by seven thin cows, who gobbled up the healthy ones; and seven plump ears of corn, succeeded by seven withering heads of corn, which also devoured the earlier ones. Joseph said that the dreams meant that there would be seven years of prosperity followed by seven years of famine. He proposed that Egypt should buy cow and corn in periods of plenty, and store them to avoid hardship during subsequent times of scarcity. Readers of the Bible know how Joseph implemented his plan, made money for the Egyptian Treasury, and became prominent in Pharaoh’s court. Alternately, Joseph could have suggested Egypt enter a series of forward contracts to buy cattle and grain for the next fourteen years. A forward contract is an agreement to trade at a later date at a forward price that is fixed when the contract starts. Basically, a forward freezes a price for a future transaction. This plan would have eased out wild price swings that come from short term demand-supply imbalances and trades would have taken place at forward prices fair to all. Of course forward traders could have defaulted and Joseph’s plan of buying, storing, and selling entailed no such risks (but it did have the risk of loss through fire and flood and other “acts of god!”). Still, the simplicity and elegance of a forward contract and its usefulness in making the markets work better by smoothing out price fluctuations can hardly be denied. Forwards are easy to construct. You and I create a forward when we decide to trade corn in three months time at a forward price of $2 per bushel. On the forward’s delivery date , you (the buyer or the “long”) will buy corn from me (the seller or the “short”) for $2. Our equal and opposite payoffs add up to zero and hence a forward is a “zero sum game.”
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This note was uploaded on 09/17/2008 for the course AEM 4210 taught by Professor Daouk,h. during the Fall '08 term at Cornell University (Engineering School).

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chap04aem421 - Jarrow, Turnbull, Chatterjea Forward and...

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