FRM Powerpoints 2011 Unit IIB Forward and Futures Contracting

FRM Powerpoints 2011 Unit IIB Forward and Futures Contracting

Info iconThis preview shows pages 1–10. Sign up to view the full content.

View Full Document Right Arrow Icon
II. Tools and Applications of Market Risk Management B. Forward and Futures Contracting
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Basic Concepts o BIS data show that as of June, 2010 size of the interest rate and FX forward market is n $81.9 trillion notional principal n $1 trillion market value n Interest rate forwards o $56.2 trillion notional principal o $81 billion market value n Currency forwards o $25.6 trillion notional principal o $925 billion market value Version: January 3, 2011 p. 2 of 66 Unit II.B **This page updated annually
Background image of page 2
Basic Concepts o Global Futures Markets n About 8.2 billion contracts traded in 2009 n But contract sizes vary, so this figure is hard to interpret Version: January 3, 2011 p. 3 of 66 Unit II.B **This page updated annually
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Forward Contracts o A forward contract is a transaction between two parties, a buyer and a seller, for the buyer to purchase an asset from the seller at a fixed price at a future date. The contract is privately negotiated between the parties, is subject to limited regulatory oversight and exposes each party to the possibility of default of the other. Version: January 3, 2011 p. 4 of 66 Unit II.B
Background image of page 4
Forward Contracts (cont.) o Fixed price: forward price o Settlement by physical delivery or cash n A agrees to pay B €100 for an asset n At expiration the asset is worth €110 n Either (as specified in the contract) o A pays €100 and receives the asset (delivery) o B pays A €10 (cash settlement; nondeliverable forward) Version: January 3, 2011 p. 5 of 66 Unit II.B
Background image of page 5

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Forward Contracts (cont.) o Strictly OTC, so they have credit risk o Our focus is on FX and interest rate forwards o Initial value is zero o Payoff based on specified notional principal Version: January 3, 2011 p. 6 of 66 Unit II.B
Background image of page 6
Forward Contracts (cont.) o A General Framework for Pricing and Valuation of Forward Contracts n Value vs. price: The value of a forward contract at expiration is the spot price of the underlying minus the forward price. n Value at initiation: The value of a forward contract when initiated is zero. n The forward price must be set at the start so that neither party can earn an arbitrage profit off of the other Version: January 3, 2011 p. 7 of 66 Unit II.B
Background image of page 7

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Forward Contracts (cont.) o A General Framework for Pricing and Valuation of Forward Contracts (cont.) Example: The one-year interest rate is 5%. Buy a stock for $100 The stock pays a $2 dividend in nine months (it will be worth $2(1.05)0.25 = $2.02 at expiration) The forward price must be 100 + 0.05(100) – 2.02 = 102.98. Version: January 3, 2011 p. 8 of 66 Unit II.B
Background image of page 8
Forward Contracts (cont.) o A General Framework for Pricing and Valuation of Forward Contracts (cont.) n What if the price is too high, say $104? o
Background image of page 9

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 10
This is the end of the preview. Sign up to access the rest of the document.

Page1 / 66

FRM Powerpoints 2011 Unit IIB Forward and Futures Contracting

This preview shows document pages 1 - 10. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online