FINM3405L1 - Course Introduction C d i Lecture 1 due to...

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Lecture 1 orward and Futures Contracts Forward and Futures Contracts Course Introduction ± due to fluctuating gold prices, a mining company cannot be sure what price they will get when their gold is extracted and processed ready for sale. ± due to fluctuating exchange rates, an Australian importer who is invoiced in USD will fear a decline in the value of the AUD. ± due to volatility in share markets, fund managers fear another market crash like 1987 which will reduce the value of their ortfolios. po t o os ± due to fluctuating interest rates, a company which knows it will need to borrow money in six months time will fear a rise in terest rates interest rates ± An orange farmer fears an unusually cold winter which will adversely impact on the crop yield. Course Overview There are three goals of this course: ± to be aware of what derivatives instruments are available in the marketplace and how they work, ± To know how to use derivatives to manage g risk in a variety of circumstances, and, o gain some insight into how derivatives are ± To gain some insight into how derivatives are valued/priced. Forward Contract ± A forward contract is an agreement between two people to exchange an asset for cash at a specified future time at a specified price. ± denote the delivery price by F and the delivery time by T
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Two Parties to the Contract ± Long forward position : contracted to buy underlying asset ± short forward position : contracted to sell the underlying asset ong hort Agrees to buy asset at time T for $ F Long Forward Position Short Forward Position Agrees to sell asset at time T for $ F Example: Hedging Sale of Wheat ± Wheat farmer: expecting to have 5000 bushels for ale in 5 mths ar decline in wheat price sale in 5 mths fear decline in wheat price ± Spot price of wheat 530 c/bushel ake hort forward contract overing 5000 bushels ± Take short forward contract covering 5000 bushels for delivery in 5 mths lock in sale price at (say) 50c. 550c. ± Counterparty: might be a miller wanting to buy 5000 bushels of wheat in 5 mths time fear price rise ± Take a long forward contract to lock in purchase price Trading Forward Contracts ± Forward contracts are traded in the over-the- counter market – OTC market is an informal market – Often trades between two financial institutions, or an institution and a client ± Financial institutions act as market makers: – Quote bid prices (price at which they will go long) – Quote offer prices (price at which they will go short) Trading Forward Contracts ± Forward contracts traded OTC can be highly customised (wrt size, timing, delivery, underlying asset) ± Performance under the forward contract is not guaranteed. Therefore, each party bears minor credit risk.
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This note was uploaded on 08/27/2009 for the course FINM 3405 taught by Professor Philipgray during the Three '09 term at Queensland.

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FINM3405L1 - Course Introduction C d i Lecture 1 due to...

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