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  1. 1. Chapter 26 – Futures Markets <ul><li>Forward Contracts </li></ul><ul><ul><li>A contract that two parties agree to today such that both parties are obligated to complete a transaction in the future </li></ul></ul><ul><ul><ul><li>Price set for transaction </li></ul></ul></ul><ul><ul><ul><li>Delivery Date set for transaction </li></ul></ul></ul><ul><ul><ul><li>Commodity set for transaction </li></ul></ul></ul><ul><ul><ul><li>Delivery Location set for transaction </li></ul></ul></ul><ul><ul><li>Examples </li></ul></ul><ul><ul><ul><li>Hotel Reservation, Airplane Ticket, Book Order </li></ul></ul></ul>
  2. 2. Chapter 26 – Futures Markets <ul><li>Futures Contracts </li></ul><ul><ul><li>Just like forward contract except </li></ul></ul><ul><ul><ul><li>Traded on an Organized Exchange </li></ul></ul></ul><ul><ul><ul><li>No money changes hands between the two parties today </li></ul></ul></ul><ul><ul><li>Terms Matching </li></ul></ul><ul><ul><ul><li>Commodity to be delivered or received is the UNDERLYING </li></ul></ul></ul><ul><ul><ul><li>Price for transaction is the FUTURES PRICE </li></ul></ul></ul><ul><ul><ul><li>Delivery Date is the SETTLEMENT DATE </li></ul></ul></ul>
  3. 3. Chapter 26 – Futures Markets <ul><li>Parties in the Futures Contract </li></ul><ul><ul><li>Buyer of the Futures Contract is “buying or taking delivery of the commodity” in the future and is said to be LONG in the contract </li></ul></ul><ul><ul><li>Seller of the Futures Contract is “selling or making delivery of the commodity” in the future and is said to be SHORT in the contract </li></ul></ul><ul><ul><li>The Exchange where the futures contracts are bought and sold </li></ul></ul><ul><ul><li>Clearing House guarantees performance </li></ul></ul>
  4. 4. Chapter 26 – Futures Markets <ul><li>Example of a Forward Contract and the Parties Economic Incentives </li></ul><ul><ul><li>Order a Book for Future Delivery </li></ul></ul><ul><ul><li>Parties </li></ul></ul><ul><ul><ul><li>Buyer of the Book </li></ul></ul></ul><ul><ul><ul><li>Bookstore </li></ul></ul></ul><ul><ul><li>Contract </li></ul></ul><ul><ul><ul><li>Commodity Book </li></ul></ul></ul><ul><ul><ul><li>Delivery Date (Three Weeks) </li></ul></ul></ul><ul><ul><ul><li>Price $15.00 </li></ul></ul></ul>
  5. 5. Chapter 26 – Futures Markets <ul><li>Example Continued </li></ul><ul><ul><li>During the 3 Week period </li></ul></ul><ul><ul><ul><li>Buyer sees “ordered” book at Borders for $12.50 </li></ul></ul></ul><ul><ul><ul><li>Buyer “skips” out of contract (fails to perform) and buys book at Borders saving $2.50 </li></ul></ul></ul><ul><ul><ul><li>Bookstore has book and no buyer </li></ul></ul></ul><ul><ul><li>During the 3 Week period </li></ul></ul><ul><ul><ul><li>Bookstore sees book selling on eBay for $19.00 </li></ul></ul></ul><ul><ul><ul><li>Bookstore “skips” out of contract and sells book on eBay for $19.00 making an extra $4 </li></ul></ul></ul><ul><ul><ul><li>Buyer of contract still waiting for book </li></ul></ul></ul>
  6. 6. Chapter 26 – Futures Markets <ul><li>Closer Look at the Contracts </li></ul><ul><ul><li>Futures Price and Spot Price and Settle Price </li></ul></ul><ul><ul><ul><li>Futures price is the contract agreed to price and varies through out the life of the contract as different parties “reach” different agreements </li></ul></ul></ul><ul><ul><ul><li>Spot price is the current market price for delivery and exchange of the commodity </li></ul></ul></ul><ul><ul><ul><li>Settle Price is the consensus price of the contract at the end of the trading day </li></ul></ul></ul><ul><ul><li>Difference between YOUR contract futures price and the consensus end of day price each day reflects profit or loss on the contract </li></ul></ul>
  7. 7. Chapter 26 – Futures Markets <ul><li>An example of an Actual Contract </li></ul><ul><ul><li>Wheat Futures at the Kansas City Board of Trade </li></ul></ul><ul><ul><ul><li>Size of Contract is 5,000 bushels </li></ul></ul></ul><ul><ul><ul><li>Commodity is Hard Red Winter Wheat </li></ul></ul></ul><ul><ul><ul><li>Delivery is at Grain Storage Facility on the Missouri River near the Railroad Shipping Yards </li></ul></ul></ul><ul><ul><ul><li>Price stated in cents per bushel, 280 </li></ul></ul></ul><ul><ul><li>What does this mean? </li></ul></ul><ul><ul><ul><li>Buyer Position and Seller Position of one contract </li></ul></ul></ul>
  8. 8. Chapter 26 – Futures Markets <ul><li>Who are the traders involved in the contracts? </li></ul><ul><ul><li>Originator of the contract </li></ul></ul><ul><ul><ul><li>Hedgers and Speculators </li></ul></ul></ul><ul><ul><ul><ul><li>Hedgers for Insurance (against future price movements) </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Speculators betting on a price movement in their favor </li></ul></ul></ul></ul><ul><ul><ul><li>Market Makers </li></ul></ul></ul><ul><ul><ul><ul><li>Dealers trading for customers </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Locals </li></ul></ul></ul></ul>
  9. 9. Chapter 26 – Futures Markets <ul><li>Profits and Losses </li></ul><ul><ul><li>Zero Sum Game </li></ul></ul><ul><ul><ul><li>For every dollar one party makes the party on the opposite side of the contract loses a dollar </li></ul></ul></ul><ul><ul><ul><li>Rising prices profit to buyer of the contract </li></ul></ul></ul><ul><ul><ul><li>Falling prices profit to seller of the contract </li></ul></ul></ul><ul><ul><ul><li>Hedgers always break even when considering their inventory position </li></ul></ul></ul><ul><ul><li>Diagrams of Payoffs for Futures </li></ul></ul>
  10. 10. Chapter 26 – Futures Markets <ul><li>Getting In and Out of Contracts </li></ul><ul><ul><li>Complete the contract (make or take delivery and pay or receive futures price) </li></ul></ul><ul><ul><li>Sell or Buy opposite position before delivery date </li></ul></ul><ul><ul><li>How can new buyer/seller be matched? </li></ul></ul><ul><ul><li>How can Clearing House guaranteeing the Performance of the buyer and seller? </li></ul></ul><ul><ul><li>MARGINS and Marking to Market </li></ul></ul>
  11. 11. Chapter 26 – Futures Markets <ul><li>Financial Futures </li></ul><ul><ul><li>Settlement in Cash </li></ul></ul><ul><ul><li>Contracts traded against “fictitious” underlying </li></ul></ul><ul><li>Questions on the Soundness of Trading Financial Futures – GAO Study </li></ul><ul><li>Governing the Futures Markets </li></ul><ul><ul><li>Self Regulating Organizations </li></ul></ul><ul><ul><li>CFTC – Commodity Futures Trading Commission </li></ul></ul>
  12. 12. Chapter 26 – Futures Markets <ul><li>What happens to the Hedger when the inventories are short of the required delivery of the contract </li></ul><ul><ul><li>Buying in the Spot </li></ul></ul><ul><ul><li>Delivery in the Spot and Close Futures Position </li></ul></ul><ul><ul><li>Gains or Losses from the different strategies </li></ul></ul><ul><li>Forward Rate Agreements </li></ul><ul><ul><li>Special Futures – i.e. a Forward Contract </li></ul></ul>