Futures - DERIVATIVES FUTURES A derivative is a contract or...

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CFA Examination DERIVATIVES - FUTURES Page 1 of 5 DERIVATIVES – FUTURES § A derivative is a contract or agreement whose value depends upon the price of some other (underlying) commodity, security or index. A. FORWARD CONTRACTS § Forward : an agreement between 2 parties that is initiated at one point in time, but requires the parties to the agreement to perform, in accordance with the terms of the agreement, at some future point in time. § Seller / Holder of the Short Position : Party obliged to Deliver the Stated Asset § Buyer / Holder of the Long Position : Party obliged to Pay for the Stated Asset § Deliverable Item/ Underlying Asset : asset to be traded under the terms of the contract § Settlement / Maturity / Expiration : Time at which the contract is to be fulfilled by the trading of the underlying asset. § Contract Size : Quantity of the underlying asset that is to be traded at the time the contract settles § Invoice Amount / Forward Contract Price : Amount that must be paid for the contract size of the underlying asset by the holder of the long position at the time of the settlement § Forward Contracts are NOT Investments; they are simply agreements to engage in a trade at a future time and at a fixed price. Thus, it costs NOTHING to enter into such a contract; Since nothing is Bought or Sold, contracts are Entered Into or Sold Out. There are THREE ways to Close Out (Settle) a contract § Enter an Offsetting Transaction : § Making/Taking Physical Delivery of the underlying commodity under the terms & conditions specified by the contract : § Cash Settlement § Over-the-Counter Forward Contracts are Flexible, but 3 major disadvantage § ILLIQUID: designed for specific needs § CREDIT RISK: No collateral or marked to marketing, rather it is just trust § UNREGULATED: no formal body regulates the players in the market B. FUTURES CONTRACTS § Futures : special forms of forward contracts that are designed to reduce the disadvantages associated with forward agreements. Indeed, they are Forwards whose terms have been STANDARDIZED to that they can be traded in a public marketplace. Less Flexible, but more liquid. § Usually traded on FUTURES exchanges, who establish terms of standardization, rules or Pit trading, daily price limit, trading hours, and settlement price methods. § Regulated by the CFTC . § Brokers: Account Executives who take orders from customers and relay them to the floor; and Floor Brokers who operate on the floor and execute orders for others and for themselves. § CLEARINGHOUSE: interposed between each side and guarantees the contract. § POSTING MARGIN, MARKING TO MARKET § Capital Gains are based upon the NET DAILY SETTLEMENT gains or losses that occur in a tax period, rather than upon the net gains or losses that result form contracts that are closed out during a tax period.
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This note was uploaded on 05/30/2011 for the course ECON 101 taught by Professor Ke during the Spring '11 term at Lethbridge College.

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Futures - DERIVATIVES FUTURES A derivative is a contract or...

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