Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: Commodity Price Behavior Behavior Weather and crop forecasts Economic factors Political factors International pressures Settle Price: the closing price (last price of the day) for commodities and financial futures Commodity Price Behavior Commodity Prices change daily Changes can be sizable Because of leverage, small unit price changes can cause large total dollar changes in contract price To protect investors, daily price change limits are set: – Daily price limit: restriction on the day­to­day change in price – Maximum daily price range: the amount a commodity price can change during the day; usually equal to twice the daily price limit Components of a Commodities Contract of Return on Invested Capital Return Commodities allow use of leverage for potentially high returns Return to investors is based upon amount of money actually invested S e llin g p ric e o f P u rc h a s e p ric e o f − c o m m o d ity c o n tra c t c o m m o d ity c o n tra c t R e tu rn o n in v e s te d c a p ita l = A m o u n t o f m a rg in d e p o s it Trading Strategies with Commodities Commodities Speculating – Capitalizing on wide swings that are characteristic of many commodities Spreading – Used by producers and processors to protect a position in a product or commodity – Producer or grower attempts to hedge as high a price as possible – Processor or manufacturer attempts to hedge as low a price as possible – No limit to the amount of loss that can occur with a futures contract Financial Futures Financial Financial Futures: future contract in which the commodity is a financial asset, such as debt securities, foreign currencies or market baskets of common stocks Often used by large institutional investors to hedge specific types of risk: – Offset interest rate risk on debt instruments – Minimize foreign currency rate risk on overseas business transactions – Minimize market risk on common stock investments Examples of Financial Futures: Examples Foreign Currency Examples of Currency Futures – British pound – Swiss franc – Canadian dollar – Japanese yen – Euro – Other currencies Examples of Financial Futures: Interest Rates Interest Examples of Interest Rate Futures – U.S. Treasury securities – Federal Funds – Interest rate swaps – Euromarket deposits – Foreign government bonds Examples of Financial Futures: Stock-Indexes Stock-Indexes Examples of Stock­Index Futures – Dow Jones Industrial Average – S&P 500 Index – Nasdaq 100 Index – Russell 2000 Index Financial Futures Contract Specifications Contract Similar to commodities contracts Control large sums of underlying financial instruments Have varying delivery dates Stock­index futures are settled in cash rather than underlying stocks of the specific stock index. Speculating in Financial Futures Speculating Allows large quantities of financial instruments to be controlled through future contract Leverage can provide high returns (or losses) “Long” positions are used if investor speculates values will go up “Short” positions are used if investor speculates values will go down Hedging with Financial Futures Hedging Effective way of protecting stock or other securities holdings in a declining market Stock­index futures used to hedge stock portfolios Interest rate futures used to hedge bond portfolios Foreign currency futures used to hedge significant exposure to foreign exchange rate risk Combining Futures and Options Combining Futures Options: options that give the holders the right to buy or sell a single standardized futures contract for a specified period of time at a specified strike price – A significant advantage that a futures option has over a futures contract is that the option limits the buyer’s loss exposure to the price of the option. Table 15.4 Futures Options: Puts Table and Calls on Futures Contracts and...
View Full Document

This note was uploaded on 10/31/2012 for the course ECON 435 taught by Professor Staff during the Fall '08 term at Maryland.

Ask a homework question - tutors are online