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IwA7nVEwqto.pdf - MITOCW | watch?v=IwA7nVEwqto The...

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MITOCW | watch?v=IwA7nVEwqtoThe following content is provided under a Creative Commons license. Your support will help MITOpenCourseWare continue to offer high quality educational resources for free. To make a donation or to viewadditional materials from hundreds of MIT courses, visit MIT OpenCourseWare at ocw.mit.edu.ANDREW LO:I hope you all had a good Columbus Day weekend. The stock market certainly did. Anyquestions from last time? No? OK. So what I want to do today is to continue talking aboutfutures and forward contracts. Today we're going to finish up on these interesting instruments,with a couple of examples, and then with a specific method for pricing forward and futurescontracts. So let me refresh your memory, it's been a week, so I know.So we're going to go back and look at a specific futures contract. And I'm going to take thiscontract and then try to talk a bit about how you might use contracts like this in hedging yourrisks, as well as in making certain kinds of bets, if you will. So remember that this contract is acontract that was issued on July 27, 2007-- so it was the middle of the summer-- for oil to bedelivered in December. And there's a specific date in December where all oil futures contractsof this type will settle-- that is will come to maturity-- where the date is going to be specified inadvance and everybody knows it. And so in July, when you buy this contract at a price of$75.06 per barrel, and each contract is for 1,000 barrels.When you quote "buy the contract," what that means is that you are agreeing today, July 27--you are agreeing today, that come December you are going to buy 1,000 barrels at a price of$75.06 per barrel. So that's the agreement. And the party who is selling you the contract, thecounterparty, is agreeing to provide you with that oil at that price in December. So the futuresprice is $75.06. And as we said last time, the current market price on July 27, 2007, that'scalled the spot price. The spot price may be higher or lower than the futures price, dependingon what expectations are for what's going to happen with oil over the subsequent six monthperiod.Now the initial margin, as I mentioned last time, was $4,050. The maintenance margin, themargin that you need to maintain. So that if the initial margin goes down in value, you have toactually put money back into your brokerage account, your margin account. And if you fallbelow that $3,000 threshold, you'll get a phone call, which is known as a margin call. Severalweeks ago, somebody told me that they've been getting lots of phone calls all from the sameperson, a person called margin. And you know that can happen when markets go awry.Now again no cash changes hands today, because the value of the contract when it's struck isa zero NPV transaction. And how do you know it's zero NPV? Again, because if it's positive for
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one party, it's coming from the other party. So which party would you like to be? You'd like tobe the party receiving that positive NPV, nobody wants to be the party that is losing the NPV.
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  • Spring '17
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