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![Pricing of Financial Futures
(example: Currency)
Forward price is an unbiased predictor of spot
exchange rate in the future (so does Futures)
Futures are priced very similarly to Forward
contracts
Based on Interest Rate Parity Theory (High
Interest Rate Currency will appreciate against Low
Interest Rate Currency)
Ft ($/i) = So ($/i) [(1+Rus)/(1+Ri)] t
Ft = Futures Price, So = Spot Price, Rus = I/R
USD, Ri = I/R Currency i](https://image.slidesharecdn.com/forwardandfuture-adlerforbbj-150114214854-conversion-gate01/85/Forward-and-Futures-38-320.jpg)
![Example: Bunga USD 5% p.a. – Bunga IDR 10% p.a.
Kurs USD/IDR tgl.3/9/2006: 10,200
Forward Rate untuk 6 bulan (jatuh tempo 3/3/2007)
adalah: 10,200 x [(1+10%)^6 / (1+5%)^6]
= 10,200 x [(1.0083)^6 / (1.0042)^6]
= 10,200 x 1.024749
= 10,452.43
Forward Price (for FX rate)
t
t
USD/IDRUSD/IDR
)r(1
)r(1
)(rateSpot)(rateForward
USD
IDR
](https://image.slidesharecdn.com/forwardandfuture-adlerforbbj-150114214854-conversion-gate01/85/Forward-and-Futures-59-320.jpg)
Uploaded byIwan Suryadi
Forward and Futures
This document discusses forwards and futures contracts. It defines forwards as agreements between two parties to buy or sell an asset at a specific price and date without standardized terms or regulation. Futures, on the other hand, are standardized contracts traded on exchanges, with clearinghouses that act as intermediaries and mark positions to market daily. The document provides examples of different derivative types and exchanges, and discusses key differences between forwards and futures regarding standardization, liquidity, counterparty risk, and other factors. It also outlines the roles that hedgers, speculators, and arbitrageurs play in the futures markets.
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Forward and Futures
- 1. Forward and Futures AdlerHaymans Manurung Guru Besar Pasar Modal dan Perbankan FE Universitas Bina Nusantara Advisor PT Bursa Berjangka Jakarta
- 2. DERIVATIF • Forwards –Commodity, Currency, and Stocks • Future - Commodity, Currency, and Stocks dan Interest Rate • Option – Stocks and Currency • Swap – Currency and Interest Rate
- 3. Futures • Hull (1997)mendefinisikan Futures: “An agreement between two parties to buy or sell an asset at a certain time in the future for a certain price” • CBOT (2006) mendefinisikan Futures: “A legally binding agreement to buy or sell a commodity or financial instrument some time in the future at a price agreed upon at the time of the trade”
- 4. Sejarah Futures • Midwestern– 1800 ----- Forward • Standardisasi 1865 - Futures • CBOT – 1848 – Berkumpul 82 pedagang • New York Mercantile Exchange, 1872 • Government US established CME 1919
- 5. Forwards • Contract betweentwo parties at specific on certain date • Non Bourse – Non regulated • Delivery System – depend on contract
- 6. Futures • Contract betweentwo parties at specific on certain date • Bourse – Regulated • Clearing Settlement
- 7. Forwards Futures Transaksi antardua pihak dapat melalui Bank Transaksi dilakukan di dalam bursa Fleksibel dan sesuai perjanjian Sangat distandardisasi Risiko pihak ketiga Ada Clearinghouse (lembaga kliring) Ada penyelesaian tunai dan diserahkan Marking to market Undang – Undang / Hukum Perdata Ada regulasi yang harus diikuti
- 8. Futures vs Forward •Dubofsky (1992) menyatakan bahwa perbedaan Futures dan forward, yaitu: – Futures contract are standardized: only the price is negotiated. – Futures contracts are usually more liquid than forward contracts, in part because they are standardized. – Once a futures price has been agreed upon and a trade completed, the exchange’s clearinghouse becomes the opposite party to both the buyer and the seller. – Most futures positions are eventually offset. – Perhaps the most important differences, at least for pricing purposes, involve security deposits (margin) and the timing of cash flows (daily resettlement, or marking to market).
- 9. Exchanges and YearFounded Principal Type of Contracts Physical Currencies Interest Rates Index Chicago Board of Trade (CBT), 1848 Chicago Mercantile Exchange (CME), 1919 Coffee, Sugar and Cocoa Exchange (New York), 1882 Commodity Exchange, Inc. (COMEX) (New York), 1933 Kansas City Board of Trade (KCBT), 1856 Mid-America Commodity Exchange (Chicago), 1880 Minneapolis Grain Exchange, 1881 New York Cotton Exchange, Inc 1870 Citrus Associates of the New York Cotton Exchange, 1966 Petroleum Associates of the New York Cotton Exchange, 1971 New York Futures Exchange (NYFE), 1979 New York Mercantile Exchange, 1872 Chicago Rice and Cotton Exchange
- 10. Exchanges Principal Types ofContracts Physical Currencies Interest Rates Stock Index Bolsa de Mercadorios de Sao Paulo London International Financial Futures Exchanges (LIFFE) Baltic International Freight Futures Exchange (BIFFEX) (London) International Petroleum Exchange (London) London Futures & Options Exchange (FOX) Tokyo International Financial Futures Exchange Osaka Securities Exchange Tokyo Commodity Exchange Tokyo Stock Exchange Singapore International Monetary Exchange (SIMEX) Marche a Terme International de France Hong Kong Futures Exchange New Zealand Futures Exchange Sydney Futures Exchange Toronto Futures Exchange Montreal Exchange Winnepeg Commodity Exchange Thailand Futures Exchange Kualalumpur Commodity Exchange Tabel 2: Non-US Futures Exchanges
- 11. Australian British CanadianDeutsche French Japanese Swiss Dollar A$ Pund Dollar Mark Franc Yen Franc Contract Size 100,000 62,500 100,000 125,000 500,000 12,500,000 125,000 Symbol AD BP CD DM FR JY SF Margin Requirements Intial in $ 1,148 1,485 608 1,755 1,755 4,590 2,565 Maintenance ($) 850 1,100 450 1,300 1,300 3,400 1,900 Minimum Price 0.0001 0.0002 0.0001 0.0001 0.00002 0.000001 0.0001 Change (1 pt.) (2 pts.) (1 pt.) (1 pt.) (2 pts.) (1 pt.) (1 pt.) Value of 1 point ($) 10.00 6.20 10.00 12.50 10.00 12.50 12.50 Months Traded Trading Hours Last Day of Trading Sumber: Alan Shapiro, Multinational Financial Management; 5th eds., Prentice Hall International, Singapore January, March, April, June, July, September, October, December, and Spot Month 7:20 A.M - 2:00 P.M. (Central Time) The Second Business day immediately preceding the third Wednesday of the delivery month Tabel 1: Contract Specificatin for Foreign Currency Futures
- 12. Bank Indonesia @2006 Market Participants Hedgers • Hedging is the opposite of speculation and describes the process of managing the price risk inherent in a business by offsetting that risk in the futures and options market. It can vary in complexity from a relatively simple activity through to a highly complex operation. • Managing price risk means: maintaining greater control of the cost of inputs or revenues from sales, or both planning for the future based on assured costs and revenues • Eliminating concerns that a sharply adverse move in a metal's price could turn an otherwise flourishing and efficient business into a loss maker
- 13. • Example A coppermining firm may sell copper futures to fix a sale price today for future copper production. By selling the futures, the firm protects profit margins and sales revenues against a potential decline in the copper price thus offsetting the price risk in the futures market. • Mutually compensatory movements in his cash and futures holdings should have cancelled out any change of price that occurred during the interval. If the grain price has dropped, the operator buys back the futures contract at less than the sale price, and the profit from doing so will be offset by the loss on the grain. Market Participants Bank Indonesia @ 2006
- 14. Bank Indonesia @2006 Market Participants SPECULATORS Speculators buy and sell futures and options contracts in an effort to profit from price trends. If speculators believe that prices will rise, they buy futures contracts. If prices do indeed rise, the speculator profits by selling the contract at the higher price. If prices fall, the speculator stands to make a loss. Typically, speculators have no desire to actually own the physical commodity. They assume market price risk and add liquidity and capital to the futures markets.
- 15. Types of Traders •Commission Brokers – are following the instructions from their clients and charge a commission for doing so • Locals – are trading for their own account • Types of Speculators: – Scalpers – attempt to profit for small changes in contract price (hold position only for minutes) – Day Traders – hold their position for less than one trading day – Position Traders – hold positions for much longer period of time
- 16. Bank Indonesia @2006 Market Participants ARBITRAGEURS • Arbitrage is the process of simultaneously buying and selling a product in related markets to earn a risk-free profit. • Arbitrageurs bridge the gap between the cash and futures market, by maintaining the price relationship between the underlying physical commodity and its futures market. • Arbitrage in commodity futures markets takes the form of cash and carry arbitrage. • This exploits a situation where the price of a particular future is higher than the spot price of the underlying commodity plus the costs of holding the commodity until delivery, i.e, storage, insurance, interest costs, etc. In this case, cash and carry arbitrage involves purchasing the underlying physical commodity and simultaneously selling its corresponding futures contract.
- 17. Bank Indonesia @2006 Market Participants Arbitrage between the commodity spot and futures markets is not as common as in financial markets because of the burden of the purchasing and delivering the underlying commodity. Example A dealer's cost for storing wheat is 10 cents per bushel. This covers transportation, security, insurance, interest costs, etc. The dealer notices that the price of wheat futures expiring in two months time is 21 cents above the spot price. The dealer sells wheat futures and purchases an equivalent amount of physical wheat, which is then stored. When the futures contract expires two months later, the dealer delivers the wheat in fulfillment of the short futures position and earns an arbitrage profit of 11 cents (21 cents less 10 cents) per bushel.
- 18. Bank Indonesia @2006 Market Participants The Hedgers pass off the risk of price variation to the Speculators, who is better able, or at least more willing to bear the risk Hedgers Speculators Risk
- 19. Keynes & Hicks •Hedgers tend to hold short positions and traders used to hold long positions • The futures price of an asset will be below its expected future spot price – normal backwardation • Note: – Because speculators require compensation for the risk they are bearing – to make money on average – Hedgers tend to loose money on average but it is aligned with the hedging purpose to enter futures – If the other way around – expected future spot price is lower than Futures price - contango
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- 23. Financial Futures Specific Features •Traded in Specific Exchanges (IMM, LIFFE etc.) • Commission • Specific periods / Settlement Dates • Standardized amounts for each contract • “Open Cry” trading in the Exchanges • Guaranteed by the “Clearing House” • Settled-Up or Marked to Market • Initial and variable Margins • Net-out-basis • Provides Opportunities to Trade, Speculate, & Hedge • Exchange provides Liquidity
- 24. Commission A certain pre-definedamount of fee paid by a buyer or seller for a round trip transactions of initiating and closing a contract Amount varies based on type of the underlying instrument,i.e. the commission charge is approximately USD30 per currency futures contract Relatively lower cost/commission imposed in futures contract reducing the cost of hedging
- 25. Specific Maturity Dates StandardizedSettlement Dates – Not Customized March, June, September, December of the year
- 26. Standardized Amount Standardized ContractAmount – Not Customized (Exchange Traded Vs OTC) Position in multiple contracts might be necessary to establish a hedge
- 27. Open Cry Client Broker Exchange Floor TradingPit Brokers & Traders Negotiated by Open Outcry
- 28.
- 29. Clearing House Servesas a the third party to all transactions Active secondary market trading No assessment of creditworthiness – because it reduce the possibility of default to zero, by the initial margin blocking and daily MTM process.
- 30. Mark to Market •Realization of profit or loss on a day to day basis • Contract Rate Vs End of Day (Closing) Rate (multiplied by respective notional) • Profit/Loss will be added/subtracted from the initial margin deposited • If initial margin minus accumulated loss < maintenance margin (75% of initial margin) – top up/liquidation
- 31. Initial & VariableMargin • 4%-10% of contract value – Initial Margin – amount of funds pledged for holding a position • Notional of Variable Margin will vary depends on the MTM profit/loss added/subtracted daily from your account • Enable Investor/Hedger to enter the whole contract amount by depositing significantly smaller margin (Leverage)
- 32. Net Out Basis •More than 90% of Futures Contracts are closed out before Settlement Date (standardized/un- customized tenor) • Without the necessity of delivery (no real position in underlying assets)
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- 34. Long Vs Short Abuyer of futures contract (one who holds long position) in which the settlement price is higher (lower) than the previous day’s settlement price has a positive (negative) settlement for the day. Since a long position entitles the owner to purchase the underlying asset, a higher (lower) settlement price means the futures price of the underlying asset has increased (decreased). Consequently a long position in the contract is worth more (less).
- 35. Long Vs Short Futurestrading between the long and short is a zero sum game; that is the sum of the long’s and short’s daily settlement is zero.
- 36. Long Vs Short Futurestrading allows Investor to do a “short selling” (you can sell first even if you do not have the underlying) Regulators in US at the moment allow a stock to be shorted only on an uptick – that is when the most recent movement in the price of the stock was an increase
- 37. Transaction Mechanism Open BUY Close SELL Open SELL Close BUY Buy LowSell High Two Ways Opportunity Bullish Strategy Bearish Strategy
- 38. Pricing of FinancialFutures (example: Currency) Forward price is an unbiased predictor of spot exchange rate in the future (so does Futures) Futures are priced very similarly to Forward contracts Based on Interest Rate Parity Theory (High Interest Rate Currency will appreciate against Low Interest Rate Currency) Ft ($/i) = So ($/i) [(1+Rus)/(1+Ri)] t Ft = Futures Price, So = Spot Price, Rus = I/R USD, Ri = I/R Currency i
- 39. Financial Futures: InterestRates 90 Days Eurodollar Contract Specifications Unit of Trading Contract Months Last Trading Day Quotation Value of 1 pt Tick Size Tick Value Current Price Pt Value x Price Final Settlement $ 1,000,000 (hypothetical $1,000,000, 90 day deposit of Eurodollar March, June, September, December 11 AM London time on the second London bank business day immediately preceding the third Wednesday of the contract month 100 minus interest rate $2,500 0.01 $25 98.375 (100 – Yield) $ 245,937.50 Based on BBA Interest Settlement Rate
- 40. Financial Futures: InterestRates FUTURES INTEREST RATES Vs PRICE • INTEREST FUTURE • RATES PRICES • 10% 94 • 9% 93 • 8% 92 • 7% 91 • 6% 90
- 41. Financial Futures: Example In June Treasurer of PT ABC knows he will need a 3 months $1mio loan on 21st June 2006 He will be paying 3M LIBOR + 1.00% A 1% rise in rates generates an extra $2,500 in interest expense How can he use financial futures to hedge his position?
- 42. Financial Futures: Example The Treasurer sells one Eurodollar contract. On that date, the contract is priced at 98.35 (100 – 1.65), with 1.65% being the implied 3 months Eurodollar for that period On the 21st June, the 3 months rate is 2.50%, giving the contract a price of 97.50 The Treasurer has made 98.35 – 97.50 = 85 ticks Price movement per tick = $25 Profit = 85 x $25 = $ 2,125
- 43. Forward-Futures Prices • SpotPrice, S. • Forward/Futures Price, F. • Interest for the period er*t dimana t setahun • F = S * er*t • Contoh: Misalkan harga currency US $ 1 = Rp. 9.300,- SBI rate 7,5% p.a. Forwad price untuk 3 bulan ke depan: – F = 9300*e7.5*0.25 = 9.476,02
- 44. Long Forward Contract Prices •Spot Price, S. Delivery Price, K. • Forward Price, F. • f = long forward contract prices • Interest for the period er*t dimana t setahun • f = S - K * e-r*t • Contoh: Misalkan harga currency US $ 1 = Rp. 9.300,- SBI rate 7,5% p.a. Forwad Contract price untuk 3 bulan ke depan bila delivery price Rp. 9.300,-: – f = 9300 - 9300*e-7.5*0.25 = 172,75
- 45. Type Traders • Hedgers –Reducing risk that they already face • Speculators – Take position to get profit • Arbitrageurs – Locking in a riskless profit by entering simultaneously into transaction in two or more markets
- 46. Notasi • T =time when the forward contract matures (years) • t = current time • S = price of asset underlying the forward contract at time t • ST = price of asset underlying the forward contract at time T (unknown at the current time t) • K = delivery price in the forward contract • f = value of long forward contract at time t • F = forward price at time t • r = risk-free rate of interest per annum at time t, with continuous compounding, for an investment maturing at time t.
- 47. FORWARD CONTRACTS ONA SECURITY THAT PROVIDES NO INCOME • Relationship between F (forward price) and S (Spot Price) : F = S*er*(T – t) • If Fmarket > S*er*(T – t) – Investor borrow S dollars for period time (T-t) – Buy the asset, take a short position in the forward contract – At time T, sold the asset, profit : F – S*er*(T – t) • If Fmarket < S*er*(T – t) – Take a long position in the forward contract & short the asset – Short position leads to a cash inflow of S that can be invested – At time T, purchase the asset, profit : S*er*(T – t) - F
- 48. Contoh 1a • Sebuahforward Contract jatuh tempo 3 bulan dimana harga sebuah saham $ 40 dan risk-free rate 3 bulan 5% p.a. Hitung futures price ? • T-t = 0.25, r = 0.05 , S = 40 • F = S*er*(T-t) = 40*e0.05*(0.25) = $ 40.50 • Jika harga aktual futures di pasar lebih besar dari $ 40.50, arbitrageur dapat meminjam uang dan membeli saham dan men-short futures contract for a net profit • Jika harga aktual futures di pasar lebih kecil dari $ 40.50, arbitrageur dapat men-short saham dan melakukan investasi, ambil futures long-position, kemudian net profit direalisasikan.
- 49. Relationship f danK • Portfolio A : one long futures contract on the security plus an amount of cash equal to K*e-r*(T- t) • Portfolio B: one unit of the security • In portfolio A, the cash, assuming that it is invested at the risk-free rate, will grow to an amount K at time T. It can then be used to pay for the security at the maturity of the forward contract. • f + K*e-r*(t-t) = S • f = S – K*e-r*(T-t)
- 50. Contoh 1b • Considera long six-month forward contract on a one-year discount bond when the delivery price is $ 950. We assume that the six month risk-free rate of interest (continuously compounded) is 6% p.a and the current bond price is $ 930. Calculate the long forward contract ? • So, T-t = 0.50; r = 0.06; K = 950; S = 930. • f = 930 – 950*e-0.06*0.5 = $ 8.08 • The value of a short forward is -$8.08
- 51. FORWARD CONTRACTS ONA SECURITY THAT PROVIDES A KNOWN CASH INCOME • Relationship between F and S : F = (S-I)*er*(T – t) • If F > (S-I)*er*(T – t) – An arbitrageur borrow S dollars for period time (T-t) – Buy the asset, take a short position in the forward contract – At time T, sold the asset, profit : F – (S-I)*er*(T – t) • If F < S*er*(T – t) – Take a long position in the forward contract & short the asset – Short position leads to a cash inflow of S that can be invested – At time T, purchase the asset, profit : (S-I)*er*(T – t) - F
- 52. Contoh 2a • Sebuahforward contract 10 bulan dengan harga saham $ 50. Risk-free rate untuk seluruh jatuh tempo 8% p.a dan ada dividen sebesar $0.75 per saham diharapkan terjadi pada akhir 3 bulan, 6 bulan dan 9 bulan. Hitung Forward Price? • Dividend (I) = 0.75*e-0.08*0.25 + 0.75*e-0.08*0.5 + 0.75*e-0.08*0.75 = 2.162 • F = (50 – 2.162)*e-0.08*10/12 = $ 51.14
- 53. Relationship f danK • Portfolio A : one long forward contract on the security plus an amount of cash equal to K*e-r*(T- t) • Portfolio B: one unit of the security plus borrowing of amount I at the risk-free rate • The income form the security can be used to repay the borrowing so that this portfolio has the same value as one unit of the security at time T. The two portfolio must therefore have the same value at time t, • f + K*e-r*(t-t) = S - I • f = S – I - K*e-r*(T-t)
- 54. Contoh 2b • Considera five-year bond with a price of $900. Suppose that a forward contract on the bond with a delivery price of $ 910 has a maturity of one year. Coupon payments of $60 are expected after six months and after twelve months. The second coupon payment is immediately prior to the delivery in the forward contract. The continuously compounded risk-free of interest for six months and one year are 9% pa and 10% pa. • PV income = 60*e-0.09*0.5 + 60*e-0.1*1 = $111.65 • f = 900 – 111.65 – 910*e-0.1*1 = - $35.05 • The value of a short position is + $35.05
- 55. FORWARD CONTRACTS ONA SECURITY THAT PROVIDES A KNOWN DIVIDEND YIELD • Assume dividend is paid continuously at an annual rate q • Relationship between F and S : F = S*e(r-q)*(T – t) • Relationship f dan K f = S*e-q*(T-t) – K*e-r(T-t)
- 56. Contoh 3 • Considera six-month forward contract on a security that is expected to provide a continuous dividend yield of 4% pa. The risk-free rate of interest (with continuous compounding) is 10% pa. The stock price is $ 25 and the delivery price is $27. • So, S = 25; K = 27; r = 0.10; q = 0.04 and T-t=0.5 • f = 25*e-0.04*0.5 – 27*e-0.1*0.5 = - $1.18 • Forward Price F = 25*e0.06*0.5 = $25.76
- 57. Profit from a LongForward Position Profit Price of Underlying at Maturity, STK
- 58. Profit from a ShortForward Position Profit Price of Underlying at Maturity, STK
- 59. Example: Bunga USD5% p.a. – Bunga IDR 10% p.a. Kurs USD/IDR tgl.3/9/2006: 10,200 Forward Rate untuk 6 bulan (jatuh tempo 3/3/2007) adalah: 10,200 x [(1+10%)^6 / (1+5%)^6] = 10,200 x [(1.0083)^6 / (1.0042)^6] = 10,200 x 1.024749 = 10,452.43 Forward Price (for FX rate) t t USD/IDRUSD/IDR )r(1 )r(1 )(rateSpot)(rateForward USD IDR
- 60. - An FRAis an OTC agreement that a certain interest rate will apply to a certain principal over a certain future period An FRA is an OTC agreement that a certain interest rate will apply to a certain principal over a certain future period - The buyer of a FRA will be compensated in cash by the seller for any rise in the reference interest rate over and above the agreed contract rate Buy a FRA to hedge against higher future interest rate (e.g. a prospective borrower expecting to get a loan in a later date) - The seller of a FRA will be compensated for any fall in interest rates Sell a FRA to hedge against future fall in interest rate (e.g. for a prospective depositor of fund) - An FRA is an off-balance sheet instrument which can achieve the same economic effect as a Forward-forward Forward Rate Agreements (FRAs)
- 61. Forward Rate Agreements(FRAs) An example of bid-offer quote on 3-mos FRAs: 3X6 3.60% 3.64% 9X12 4.31% 4.35% Settlement formula for a FRA: (LIBOR – Fixed Rate) X (Notional Amount) X (days / 360)
- 62. An example ofFRAs Deal PT AHM Bank NKRI 3.64% 3-mos LIBOR (in month 3) Loan Pay 3-mos LIBOR (4% pa) FRAs Dealer Jika pada saat settlement ternyata LIBOR naik menjadi 4%, maka PT AHM akan menerima: (0.04 – 0.0364) X (1 juta) X (90/360) = USD 1,150 Uang ini sebagai kompensasi bunga LIBOR lebih yang harus dibayarkan ke Bank NKRI pada tingkat 4% pa Biaya bunga dapat fixed di 3.64% Misalkan PT AHM ingin pinjam USD 1 juta 3 bulan dari sekarang dengan bunga tetap: Sells a FRA Buys a FRA
- 63. o Contract Currencyand notional Amount (of the notional loan or deposit) o Contract period – period from settlement date to maturity o Settlement Date – when the contract period commences and cash compensation is paid o Maturity date – date when contract period ends o Contract Rate – the agreed rate of interest for the contract period (FRA price) o Fixing Date – normally two business days before the settlement date when the LIBOR reference rate on which the settlement amount is established, but fixing date may be the same as settlement date The Usual FRAs Contract Terms
- 64. Forwards vs FRAs •Forwards Hedging against Market Risk (price fluctuations) • FRAs Hedging against Interest Rate Risk
- 65.