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Chapter 26 – Futures Markets

Chapter 26 – Futures Markets. Forward Contracts A contract that two parties agree to today such that both parties are obligated to complete a transaction in the future Price set for transaction Delivery Date set for transaction Commodity set for transaction

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Chapter 26 – Futures Markets

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  1. Chapter 26 – Futures Markets • Forward Contracts • A contract that two parties agree to today such that both parties are obligated to complete a transaction in the future • Price set for transaction • Delivery Date set for transaction • Commodity set for transaction • Delivery Location set for transaction • Examples • Hotel Reservation, Airplane Ticket, Book Order

  2. Chapter 26 – Futures Markets • Futures Contracts • Just like forward contract except • Traded on an Organized Exchange • No money changes hands between the two parties today • Terms Matching • Commodity to be delivered or received is the UNDERLYING • Price for transaction is the FUTURES PRICE • Delivery Date is the SETTLEMENT DATE

  3. Chapter 26 – Futures Markets • Parties in the Futures Contract • 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 • 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 • The Exchange where the futures contracts are bought and sold • Clearing House guarantees performance

  4. Chapter 26 – Futures Markets • Example of a Forward Contract and the Parties Economic Incentives • Order a Book for Future Delivery • Parties • Buyer of the Book • Bookstore • Contract • Commodity Book • Delivery Date (Three Weeks) • Price $15.00

  5. Chapter 26 – Futures Markets • Example Continued • During the 3 Week period • Buyer sees “ordered” book at Borders for $12.50 • Buyer “skips” out of contract (fails to perform) and buys book at Borders saving $2.50 • Bookstore has book and no buyer • During the 3 Week period • Bookstore sees book selling on eBay for $19.00 • Bookstore “skips” out of contract and sells book on eBay for $19.00 making an extra $4 • Buyer of contract still waiting for book

  6. Chapter 26 – Futures Markets • Closer Look at the Contracts • Futures Price and Spot Price and Settle Price • Futures price is the contract agreed to price and varies through out the life of the contract as different parties “reach” different agreements • Spot price is the current market price for delivery and exchange of the commodity • Settle Price is the consensus price of the contract at the end of the trading day • Difference between YOUR contract futures price and the consensus end of day price each day reflects profit or loss on the contract

  7. Chapter 26 – Futures Markets • An example of an Actual Contract • Wheat Futures at the Kansas City Board of Trade • Size of Contract is 5,000 bushels • Commodity is Hard Red Winter Wheat • Delivery is at Grain Storage Facility on the Missouri River near the Railroad Shipping Yards • Price stated in cents per bushel, 280 • What does this mean? • Buyer Position and Seller Position of one contract

  8. Chapter 26 – Futures Markets • Who are the traders involved in the contracts? • Originator of the contract • Hedgers and Speculators • Hedgers for Insurance (against future price movements) • Speculators betting on a price movement in their favor • Market Makers • Dealers trading for customers • Locals

  9. Chapter 26 – Futures Markets • Profits and Losses • Zero Sum Game • For every dollar one party makes the party on the opposite side of the contract loses a dollar • Rising prices profit to buyer of the contract • Falling prices profit to seller of the contract • Hedgers always break even when considering their inventory position • Diagrams of Payoffs for Futures

  10. Chapter 26 – Futures Markets • Getting In and Out of Contracts • Complete the contract (make or take delivery and pay or receive futures price) • Sell or Buy opposite position before delivery date • How can new buyer/seller be matched? • How can Clearing House guaranteeing the Performance of the buyer and seller? • MARGINS and Marking to Market

  11. Chapter 26 – Futures Markets • Financial Futures • Settlement in Cash • Contracts traded against “fictitious” underlying • Questions on the Soundness of Trading Financial Futures – GAO Study • Governing the Futures Markets • Self Regulating Organizations • CFTC – Commodity Futures Trading Commission

  12. Chapter 26 – Futures Markets • What happens to the Hedger when the inventories are short of the required delivery of the contract • Buying in the Spot • Delivery in the Spot and Close Futures Position • Gains or Losses from the different strategies • Forward Rate Agreements • Special Futures – i.e. a Forward Contract

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