Beruflich Dokumente
Kultur Dokumente
Week 10
Futures Contracts and Forward Rate
Agreements
Note: These are both derivatives because they derive their price
from an underlying physical or financial market product.
Margin requirements:
o The buyer (long position) and the seller (short position) both pay an
initial margin, held by the clearing house, rather than the full
price of the contract.
Contract delivery:
o Most parties want to manage risk/speculate and never actually
deliver or receive the underlying commodity/instrument and close
out the contract prior to the delivery date.
o Sydney Futures Exchange (SFE) requires financial futures in
existence at the close of trading in the contract month to be
settled with the clearing house either;
Cash settlement
www.sfe.com.au
Is freely traded
EXAMPLES:
o
Commodities:
Financial:
2) Speculators:
o Expose themselves to risk to make profit
o Enter into the market with the expectation that the market price will
move in a direction favourable for them
3) Traders:
o These are a type of speculator
o They trade on very short-term changes in the price of futures
contracts (intra-day changes)
o They provide liquidity to the market.
4) Arbitragers:
o Simultaneously buy and sell to take advantage of price differentials
between markets.
o Attempt to make profit without taking any risk
Margin Payments:
o Initial margin required when entering into a futures contract.
o Further cash is required if prices move adversely (margin calls)
o Opportunity costs associated with margin requirements.
Basis Risk: Perfect hedge has zero initial AND final basis risk
o Initial basis:
>>Difference between the price in the physical market and the
futures market at commencement of a hedging strategy.
o Final basis:
>> Difference between the price in the physical market and the
futures market at the completion of a hedging strategy.
Cross-commodity hedging:
o Using a commodity or financial instrument to hedge a risk associated
with another commodity or financial instrument.
o Selection of futures contract with price movements highly correlated
with the price of the commodity or instrument to be hedged.
Advantages:
o Tailor-made, OTC contract with good flexibility with respect to period
and amount of each contract.
o Unlike futures contract FRA does NOT HAVE MARGIN PAYMENTS
Disadvantages:
o Credit risk (risk of non-settlement)
o No formal market exists
Specifications?
o FRA agreed date, fixed at start of FRA
o Notional principal amount of the interest cover
o FRA settlement date when compensation paid
o Contract period on which the FRA interest rate cover is based (end
date)
o Reference rate to be applied at the settlement date
o
= FRA settlement rate FRA agreed rate:
o
o Where:
Example:
On 19 September this year a company wishes to lock in the interest rate on
a prospective borrowing of $5 000 000 for a six-month period from 19 April
next year to 19 October of the same year. An FRA dealer quotes 7Mv13M
(19) 13.25 to 20. On 19 April the BBSW on 190-day money is 13.95% per
annum.
o is =
o ic =
P=
o
000 000
$5
Due to interest rates rising over the period the settlement amount is paid
by the FRA dealer to the company.