FIN 401- Ch. 17 class notes. ppt

FIN 401- Ch. 17 class notes. ppt - FIN 401 Principles of...

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FIN 401 – Principles of Investments and Security Markets Chapter 17: Futures Markets and Risk Management
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2 Futures and Forwards Futures and forward contracts are like options…they specify purchase or sale of some underlying asset at some future date. However, in the case of futures or forward contracts, both parties have the obligation to go through with the agreed- upon transaction. These instruments offer powerful means to hedge other investments.
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3 Futures and Forwards Consider the case of an oil production company. The revenue of this company depends on oil prices, which are extremely volatile. This company cannot easily diversify… On the other hand, consider a company that has to buy oil as one of the inputs in the production process. This company has a problem that is the mirror of the oil production company. This subjects the company to profit unpredictability because of the volatile oil prices. How can forwards and futures help these two firms?
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4 Futures and Forwards It turns out that forwards and futures can help reduce this uncertainty… The parties can reduce the source of risk if they enter a forward contract. This requires that the oil producer delivers oil at a price agreed upon now, regardless of the market price at the time when oil is produced. This requires that BOTH parties be willing to lock in the price to be paid or received for delivery of the commodity.
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5 Forwards versus Futures Forwards Futures Private contract between two parties Traded on an exchange Not standardized Standardized contract Specified delivery date (usually) Range of delivery dates **Settled at end of contract **Settled daily Delivery or final cash settlement usually takes place Contract usually closed out prior to maturity
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6 Futures Contracts A futures contract calls for delivery of a commodity at a specified delivery or maturity date, for an agreed-upon price, called the futures price , to be paid on contract maturity. The trader taking the long position commits to purchasing the commodity on delivery date. The trader taking the short position commits to delivering the commodity at contract maturity.
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7 Futures Contracts The trader in the long position is said to “buy” a contract; the short-side trader “sells” a contract. At maturity: Profit to long = Spot price at maturity – Original futures price Profit to short = Original futures price - Spot price at maturity The spot price is the actual market price of the commodity at the time of the delivery.
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8 Payoffs From Futures Contracts Asset price at maturity Payoff 0 K K: Delivery price LONG POSITION
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9 Payoffs From Futures Contracts Asset price at maturity Payoff 0 K K: Delivery price SHORT POSITION
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Futures Contracts The futures contract is a zero-sum game. The losses and gains to all positions net out to zero. Every long position is offset by a short position. The aggregate profits to futures trading, summing over all
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FIN 401- Ch. 17 class notes. ppt - FIN 401 Principles of...

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