M01_MCDO8122_01_ISM_C01

M01_MCDO8122_01_ISM_C01 - Chapter 1 Introduction to...

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Chapter 1 Introduction to Derivatives n Question 1.1 We will look at the CME 1. The CME trades derivatives (specifically futures and options on futures) on a wide variety of assets and indices/variables. Assets include basic commodities such as Cattle, Hogs, Pork Bellies, Lumber, Milk, and Butter. Derivatives are also traded on weather (various measures of temperature), stock indices (such as the S&P, NASDAQ, Nikkei, and Russell), interest rates (such as the Eurodollar interest rate), and currencies. 2. At the time of this writing, monthly trading volume is available from: http://www.cme.com/trading/dta/hist/monthly_volume.html. Table 1.1 summarizes the trading volume for October 2007 for the major classes of asset types. Table 1.1 CME Trading Volume, October 2007 Volume Month Ago Year Ago Jan-Oct, 2007 Jan-Oct, 2006 Futures Commodity & Others 1,370,451 1,528,494 1,408,670 15,877,224 14,528,206 Currency 11,832,907 11,710,211 8,723,870 116,996,045 87,876,871 Equity & Index 59,972,745 55,584,345 38,230,166 516,159,044 387,933,512 Interest Rate 46,012,514 49,812,941 46,537,725 528,881,778 419,626,901 Options Commodity & Others 223,690 1,90,723 1,587,41 1,661,814 1,536,658 Currency 4,26,897 3,51,360 2,27,990 3,501,472 2,668,271 Equity & Index 31,97,318 2,643,714 2,848,116 34,983,389 22,773,974 Interest Rate 19,447,226 27,739,787 21,993,883 273,280,944 233,235,408 3. For notional value, consider the exchange rate contracts traded on the CME as shown in Table 1.2. As we can see, contract size (i.e., number of units of the currency) for currencies with a lower US dollar value (e.g., the Japanese Yen) are larger. If the exchange chose to cut the size of the contract in half, traders would likely double their volume (all else equal) leaving notional volume constant. Table 1.2 demonstrates that volume alone might not capture the relative economic significance of the contracts. For example, the Euro contracts have approximately 3.8 times the trading volume of Australia, but the notational value is close to 7 times.
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2 McDonald • Fundamentals of Derivatives Markets Table 1.2 CME FX Trading Volume, October 2007 Volume Contract Size FX (USD) Contract Not1. Value Oct. Not1. Value AUST DLR 1,015,852 100,000 0.9194 $ 91940.00 $ 93,397,432,880 BRIT PND 1,729,780 62,500 2.0633 $128956.25 $223,065,942,125 CANADA DLR 1,053,991 100,000 1.0475 $104750.00 $110,405,557,250 EURO FX 3,831,543 125,000 1.4410 $180125.00 $690,156,682,875 JAPAN YEN 2,493,072 12,500,000 0.0087 $109012.50 $271,776,011,400 MEX PESO 403,697 500,000 0.0933 $ 46640.00 $ 18,828,428,080 SWISS FRNC 1,129,810 125,000 0.8590 $107375.00 $121,313,348,750 n Question 1.2 1. Trader A initially entered 20 long contracts and then reversed the 20 positions, hence having a net position of 0 contracts at the end of the day. Trader B had 5 short contracts initially, but his trade of 10 long contracts nets to 5 long contracts at the end of the day. Trader C has 25 short contracts and lowers this by 20, hence having a net position of 5 short contracts. Notice the total net position is, as it must always be for derivative contracts, zero; for every long position, there is a short position. 2. The four trades have a total volume of 5 15 10 20 50. + + + = At the end of the day, the open interest is 5 (Traders B and C have these offsetting positions open). The notional value of the volume is 50 $100 $5000 × = and the notional value of the open interest is 5 $100 $500. × = 3. If the final trade had C going long 5 contracts, with B going short on the opposite side, the 5 open positions from our previous answer would be closed. Volume for the day would be 55, notional volume would be $5500, and open interest would be zero.
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