Future Markets and Contracts . Presentation prepared for MBA course "Treasury Management"

2. In the financial marketplace some instruments are
regarded as fundamentals, while others are regarded
as derivatives.
Financial Marketplace
Derivatives Fundamentals
Futures
Forwards
Options
Swaps
Stocks Bonds

3. An agreement between a buyer
and a seller to receive or deliver a
product on a future date at a price
they have negotiated TODAY.
What Is A Futures Contract?

4. Forward
• Private contracts between two parties
• Not standardize
• Usually are one specific deliver date
settle at end of contract
• Delivery or final cash settlement takes
place
• Some credit risk exist
Future
• Traded on an exchange
• Standardize contract
• Range of delivery dates
• Settled daily ( marked to market)
• Contract is usually close out prior to
maturity
• No credit risk
• Clearing house of the exchange
guarantee payments to both parties

5. Contract standardized with respect to:
Delivery Period
(timing)
Contract Size
(quantity) Quality of the
Product The manner of
delivery
Exchange set the
Minimum price
fluctuation ( Tick
Size)
Exchange also set
the trading timings
The only
negotiable terms
are price and the
number of
contracts involved
in each trade.

6. Transaction will not be completed until some agreed-upon date in the
future
Delivery date and quantity are all set when the financial future is created
Seller has legally binding obligation to make delivery on specified date
Buyer/holder has legally binding obligation to take delivery on specified
date
Futures may be held until delivery date or traded on futures market
All trading is done on a margin basis
The futures price is simply what a buyer is willing to pay and a seller is
willing to accept for a product. The exchange (CME, NYBT, CBOT) itself does
not set prices.
Once you’ve established a “long”
(buy) or “short” (sell) position in the
futures market, the value of your
position (gain or loss) changes each
time prices change.

8. • Hedger are in the position where they face
risk associated with the price of an asset .
They use derivative to reduce / eliminate
risk
• Example : Farmers will sell futures to
guarantee the price at which they will be
able to sell their wheat
Using Future
contract by
Hedger
• Speculator wish to bet on future movement
in the price of an asset
• They use derivative to get extra leverage –
high return
Using Future
Contract by
Speculators

9. Short
Position
• A Seller of a future contract has a short
position
• Short has an obligation to sell at contract price
Long
Position
• A trader who contacts a broker and buys
future is said to have a long position
• The long has contracted to buy the asset at the
contract price at contract expiration

10. When one “buys” a futures contract, one agrees
with the exchange to a daily settlement procedure
that is only loosely analogous to buying the
commodity. One must post initial margin with the
futures commission merchant.
Usually, one has no intention of
taking delivery of the commodity
Same as when one “sells” a futures
contract, no intention of selling the
commodity. Again, post margin.

11. 15-12

12. Each Exchange has a clearinghouse
Clearing house guarantees that traders in the
future market will honor their obligations
It acts as the buyer to every seller and the seller
to every buyer
Traders can easily reverse their positions from
long to short at future date

13. Margin in Securities Markets
• Margin on a stock/bond is a
percentage of the market
value of the asset
• 50% of stock purchase by
borrowed amount, interest
charged on the borrowed
amount is margin loan
Margin in Future Markets
• Margin is a performance
guarantee.
• It’s the money deposited by
both the long and the short
• No loan involved , no
interest charges

14. Initial margin: The amount deposited in a future
account . It equals about one day’s price settlement
• If balance falls below maintenance margin , a margin call take place and fund
must be added back to the amount of initial margin
• If funds not added , position is liquid
Maintenance margin: The amount of margin that must be
maintained in a future account
• Usually settled in cash with the broker each morning
Variation margin – is the funds that must be deposited into the
account to bring it back to the initial margin amount

15. • Daily Price limit ( up / down )= $
0.02
Previous day
settlement Price =
$1.04
• No trade will take place
• Settlement Price will be reported as
$1.06 ( Mark to Market),
• the contract will be LIMIT MOVE , PRICE
=> LIMIT UP
If today traders wishes
to trade at $1.07
• No trade will take place
• Settlement Price will be reported as
$1.02( Mark to Market ) ,
• the contract will be LIMIT MOVE , PRICE
=> LIMIT DOWN
If Today traders wishes
to trade below $1.02
Locked
Limit

16. Five July
Wheat
Contracts
Each
contract
covers
5,000
bushels
Initial Margin per Contract =
$ 150 => so for 5 contracts
TOTAL Initial Margin = 5 *
150 = $ 750
Maintenance Margin
per Contract = $ 100 =>
so for 5 contracts = 5 *
100 => $500
Price change of a cent $0.01 per
bushel changes a contract value by
= 5000 * 0.01 = $50
So each 5 contracts = 5 * $50 = $250

17. Day
Required
Deposit
Price /
Bushel
Daily Change Gain / Loss Balance
0 ( Purchase) $750 $2.00 0 0 $750
1 0 $1.98 -$0.02 -$500 $250
2 $500 $1.99 +0.01 +250 $1000
3 0 $1.98 -0.01 -$250 $750

18. 4 ways to terminate a future contract
Delivery
:Short by
delivering
the goods
,long by
paying price
to short
Cash
Settlement
Price
Reversing
Position
Exchange for
physicals

19. • Eurodollar
• U.S. Treasury Bills
Short term
future
contracts
• U.S. Treasury NotesIntermediate
Future
Contracts
• U.S. Treasury Bonds
Long Term
Future Contract

20. 21
T-bill price = Face value - Discount amount
Days to maturity
Discount amount = Face value ( ) Ask discount
360
 

21. U.S. Treasury bills Future Contracts:
• Example
• A 90-day (13 weeks) T-bill future contract , face value $1
Million. Price quote as $98.52
• Annualized discount %= (100 - 98.52 )/100 = 0.0148 or 1.48%
• Actual Discount % = 0.0148 * (90 / 360 ) = 0.0037
• Discount Amount = Face Value * 0.0037 = $3,700
• Delivery Price = Face Value – Discount Amount
• = $1000,000 - $3,700 = $996,300

22. U.S. Treasury bills / Eurodollar Tick Size
• T-Bills / Eurodollar of 90 days of $1 Million Future Contract
• Each change in Price of 1 cent ( $0.01) of a T-Bills /
Eurodollar ,discount of 0.01 %
• 0.01 %*( 90/360) * $ 1 Million = $25
• A price change 1 cent in T-bill / Eurodollar represent change
of $25 in contract of $1 Million
• e.g. Price falls from $98.52 to $98.50 , $50 loss per contract

23. T-notes have a life of less than ten year
• T-bonds are callable fifteen years after they are issued
U.S. Treasury bond futures:
• Pay semiannual interest
• Have a maturity of up to 30 years
• Trade readily in the capital markets
U.S. Treasury bonds differ from U.S. Treasury notes:
• Call for the delivery of $100,000 face value of U.S. T-bonds
• With a minimum of fifteen years until maturity (fifteen years of call
protection for callable bonds)
• Bonds that meet these criteria are deliverable bonds
A conversion factor is used to standardize deliverable bonds:
• The conversion is to bonds yielding 6 percent
• Published by the Chicago Board of Trade
• Is used to determine the invoice price

25. Suppose $1000 Treasury bond with 8% coupon, currently trading at 92,
6% short term rate
If futures contract selling at 910:
Now:
Borrow funds +920
Buy bond -920
Sell Treasury futures 0
Net cash flow 0
One year later:
Receive coupon +80
Deliver bond at contract price +910
Pay off loan -920
Pay off loan interest _55
Net cash flow +15
Which bond to buy? "Cheapest to deliver"

26. If futures contract selling at 880:
Now:
Short bond in cash market +920
Invest funds at 6% -920
Buy bond futures 0
Net Cash Flow 0
One year later:
Receive loan principal +920
Receive loan interest +55
Pay coupon on shorted bond -80
Buy bond at contracted price -880
Deliver on bond ___ _
Net Cash Flow 15

27. Profit and loss of a futures transaction
A march 2005 treasury bond futures contract
traded on CBT on Jan. 10, 2005 is 112 11/32 (or
112.34375) percent of the face value of the T-bond.
The contract size is $100,000. So the position can
be taken with a price of $112,343.75.
The subsequent movement of the T-bond futures
price falls to 111-16 (111.5%), the long position
incurs a loss of (111.5-112.34375)%*100,000
= -$843.75.

28. Currencies Standard Contract Sizes:
• 1) British pound [ contract size = 62,500 ]
• 2) Euro [ contract size = 125,000 Euro]
• 3) Canadian dollar
• 4) Japanese yen
• 5) Deutsche mark
• 6) Australian dollar
• 7) Swiss franc

29. Currency Future :Long and Short Exposures
A person that is, for example, long the pound, has pound
denominated assets that exceed in value their pound
denominated liabilities.
A person that is short the pound, has pound denominated
liabilities that exceed in value their pound denominated
assets.

30. Hedging With a Currency Future
To hedge a foreign exchange exposure, the customer assumes a
position in the opposite direction of the exposure.
For example, if the customer is long the pound, they would short
the futures market.
A customer that is long in the futures market is betting on an
increase in the value of the currency, whereas with a short position
they are betting on a decrease in the value of the currency.

31. Example
The parent company has a foreign exchange exposure, as
the dollar value of the profits will rise and fall with
changes in the exchange value between the MP and the
dollar.
A US manufacturing company has a division that operates
in Mexico. At the end of June the parent company
anticipates that the foreign division will have profits of 4
million Mexican pesos (MP) to repatriate.

32. The firm is
long the
peso, so to
hedge the
exposure
they will go
short in the
futures
market.
The face
amount of each
peso future
contract is
MP500,000, so
the firm will go
short 8
contracts.
If the peso
depreciates, the
dollar value of the
division’s profits
falls, but the future
account generates
profits, at least
partially offsetting
the loss. The
opposite holds for
an appreciation of
the peso.

33. Change spot value
Change in
futures price
Gain
Loss
Underlying
Long
Position
Futures Position
This diagram illustrates the
effect of a change in the value of
the peso.
An increase in the value of the
peso increases the dollar value of
the underlying long position and
decreases the value of the
futures position.
A decrease in the value of the
peso decreases the value of the
underlying position and
increases the value of the futures
position.

34. On the 25th, the spot rate
opens at 0.10660 ($/MP)
while the price on a MP
future opens at 0.10310.
The market closes at
0.10635 and 0.10258
respectively.
The loss on the underlying
position is:
•(0.10635-0.10660)MP4 mil. = -
$1,000
The gain on the futures
position is:
•(0.10310-
0.10258)8MP500,000=$2,080
Gain and Loss on Underlying and Futures Position
Day 1

35. Change spot value
Change in futures price
Gain
Loss
Underlying Long Position
MP4 million
Futures Position
MP500,000 x 8
-0.00025
-0.00052
$1,000
$2,080
Gain and Loss on Underlying and Futures Position
Day 1

36. On the 28th, the spot rate moves to 0.10670
($/MP) and the price on a MP future to
0.10285.
The gain on the underlying position is:
• (0.10670-0.10635)MP4 mil. = $1,400
The loss on the futures position is:
• (0.10258-0.10285)8MP500,000=-$1,080
Gain and Loss on Underlying and Futures
Position Day 2

37. Change spot value
Change in futures price
Gain
Loss
Underlying Long Position
MP4 million
Futures Position
MP500,000 x 8
$1,080
$1,400
0.00035
0.00032
Gain and Loss on Underlying and Futures Position
Day 2

38. On the 29th, the spot
rate moves to 0.10680
($/MP) and the price on
a MP future to 0.10290.
The gain on the underlying
position is:
• (0.10680-0.10670)MP4 mil. =
$400
The loss on the futures position is:
• (0.10285-0.10290)8MP500,000=-$200
Gain and Loss on Underlying and Futures
Position Day 3

39. Change spot value
Change in futures price
Gain
Loss
Underlying Long Position
MP4 million
Futures Position
MP500,000 x 8
$200
$400
0.00005
0.0001
Gain and Loss on Underlying and Futures Position
Day 3

40. For the three days considered, the
underlying position gained $800
in value and the futures contracts
yielded $800.
The hedge was not perfect as the
daily losses on the futures were less
than the gains on the underlying
position (day 2 and 3), and the daily
gains on the futures exceeded the
losses on the underlying position
(day 1).
In this example, the
imperfect hedge
yielded additional
gains.