This preview has intentionally blurred sections. Sign up to view the full version.View Full Document
Unformatted text preview: Chapter 19 Futures contracts and forward rate agreements Learning objective 1: consider the nature and purpose of derivative products and the use of a futures contract to hedge a specific risk exposure • A derivative is a risk management product that derives its value from an underlying commodity or financial instrument. • A futures contract is a derivative product that may be used to manage risk exposures to interest rates, exchange rates, share prices and commodity prices. • The risk management function of a derivatives-based strategy is to lock-in a price today that will apply at a future date. • A futures contract is an agreement between two parties to buy, or sell, a specified commodity or financial instrument at a specified date in the future, at a price that is determined today. • The contracts are standardised by the contract size, the underlying commodity and delivery dates. • Basic futures strategy rule: conduct a transaction in the futures market today that corresponds with the proposed physical market transaction due at a later date. • For example, if a risk manager intends to buy at a later date in the share market, then they would buy a share based futures contract today. The open position is closed-out at the maturity date. Learning objective 2: discuss the main features of a futures transaction, including orders and agreement to trade, calculations, margin requirements, closing out a contract and contract delivery • Futures contracts are standardised exchange-traded contracts available on futures exchanges such as the Chicago Board of Trade (USA) or the Sydney Futures Exchange (Australia). • Each exchange offers a set of futures contracts which are often based on underlying commodities and financial instruments available in the local physical or spot markets. • Most exchanges use electronic trading, although some open outcry exchanges still operate. • Buy or sell orders are placed through a broker. • The SFE quotes bond and bill futures contracts at an index of 100 minus the yield; for example, a Treasury bond futures contract yielding 7.00 per cent is quoted at 93.000. • Transactions are conducted through the exchange’s clearing house. • An initial margin payment is paid to the clearing house. • Contracts are marked-to-market each day. Maintenance margin calls may be required. • An open position is closed out by buying or selling an identical contract, but opposite to the initial futures contract. • The exchange will specify if settlement is by standard delivery or by cash payment. • By conducting two transactions—buy and sell—the party will make either a profit or a loss on those transactions....
View Full Document
This note was uploaded on 03/26/2012 for the course FIN 1612 at University of New South Wales.