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CHAPTER 11 Martellini Lecture

CHAPTER 11 Martellini Lecture - CHAPTER 11 MARTELLINI...

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CHAPTER 11 MARTELLINI FORWARDS AND FUTURES A forward contract or a futures contract is: An agreement made on a date t to buy (long position) or To sell (short position) a security on a future date T The future date is the delivery date At a given price called the forward or futures price The forward or futures price is computed so that the value of the contract on date t is equal to 0 On date T , the seller of the contract delivers the security to the buyer at the futures price If the long side of a contract gains, the short side loses so that it is a zero-sum game Similarities: Futures contracts are similar to forward contracts but are standardized and exchanged on recognized futures markets Differences: Forward contracts are designed to meet specific individual requirements and traded OTC The main markets of interest rate futures contracts in the world are: The International Money Market of the Chicago Mercantile Exchange (CME) The Chicago Board of Trade (CBOT) The Montreal Stock Exchange Futures The London International Financial Futures Exchange Eurex The Hong Kong Futures Exchange TERMINOLOGY, CONVENTIONS, AND MARKET QUOTES A futures contract is: An agreement between two parties That specifies the characteristics of the contract as any other agreement would 1
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KEY TERMS AND CONVENTIONS The Underlying Asset: Is the asset that the seller delivers to the buyer at the end of the contract May exist, as in the case for an interest rate or a bill It may not exist, as in the case for a bond For a bond, there is a difference between the fictitious underlying asset of the contract and the asset that will be actually delivered. A contract must stipulate the grades of the underlying assets that are acceptable for delivering The Contract Size: Corresponds to the notional, or speculative, amount of the asset that has to be delivered Delivery Month: The month when the contract expires For each delivery month of a contract, there is a calendar specifying the last trading day, and if necessary, the repartition or allotment day when sellers determine which assets they will deliver to buyers Also, if necessary, the delivery day, or delivery period, when assets are delivered, which are referred to in calculating the conversion factor and accrued interest. See Example 11.5 on page 355 of textbook. Quotes: The futures price is quoted differently depending on the nature of the underlying asset, an interest rate, a bill or a bond. When the underlying asset is an interest rate, the futures price is quoted with 3
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