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topic02_pres - EC372 Bond and Derivatives Markets Futures...

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EC372 Bond and Derivatives Markets Futures Markets I: Basic Ideas R. E. Bailey Department of Economics University of Essex University week 17 EC372 Bond and Derivatives Markets Futures Markets I Topic #2
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Outline 1 Forward and futures contracts Futures contracts Operation of futures markets 2 Arbitrage between spot and forward prices 3 Arbitrage in foreign exchange markets 4 REPO agreements and markets Reading: Economics of Financial Markets , chapter 14 EC372 Bond and Derivatives Markets Futures Markets I Topic #2
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Outline Forward and futures contracts Forward and futures contracts I Forward contract: two parties agree today to take a future action I Example : seller agrees to deliver a specified ‘good’ (asset) at a specified place on a specified date; the buyer agrees to take delivery and to make payment. I Payment takes place at date T (delivery), but a ‘good faith’ deposit may be made earlier. I F ( t , T ) = price agreed at t for delivery at T . I Spot contract: immediate delivery. Spot price: p ( t ) = F ( t , t ) I Three categories of traders: 1 Arbitrageurs: exploit spot and forward price differentials 2 Speculators: profit from perceived superior expectations 3 Hedgers: trade to eliminate or reduce future price risk I Forward contracts enable traders to eliminate price risk – but not performance risk EC372 Bond and Derivatives Markets Futures Markets I Topic #2
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Outline Forward and futures contracts Forward and futures contracts I Forward contract: two parties agree today to take a future action I Example : seller agrees to deliver a specified ‘good’ (asset) at a specified place on a specified date; the buyer agrees to take delivery and to make payment. I Payment takes place at date T (delivery), but a ‘good faith’ deposit may be made earlier. I F ( t , T ) = price agreed at t for delivery at T . I Spot contract: immediate delivery. Spot price: p ( t ) = F ( t , t ) I Three categories of traders: 1 Arbitrageurs: exploit spot and forward price differentials 2 Speculators: profit from perceived superior expectations 3 Hedgers: trade to eliminate or reduce future price risk I Forward contracts enable traders to eliminate price risk – but not performance risk EC372 Bond and Derivatives Markets Futures Markets I Topic #2
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Outline Forward and futures contracts Forward and futures contracts I Forward contract: two parties agree today to take a future action I Example : seller agrees to deliver a specified ‘good’ (asset) at a specified place on a specified date; the buyer agrees to take delivery and to make payment. I Payment takes place at date T (delivery), but a ‘good faith’ deposit may be made earlier. I F ( t , T ) = price agreed at t for delivery at T . I Spot contract: immediate delivery. Spot price: p ( t ) = F ( t , t ) I Three categories of traders: 1 Arbitrageurs: exploit spot and forward price differentials 2 Speculators: profit from perceived superior expectations 3 Hedgers: trade to eliminate or reduce future price risk I Forward contracts enable traders to eliminate price risk – but not performance risk EC372 Bond and Derivatives Markets Futures Markets I Topic #2
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