Futures contract

Derivatives

1. A security whose price is dependent upon or derived from one or more underlying assets

2. Value of derivative is determined by fluctuations in the underlying asset

3. The most common underlying assets – stocks, bonds, commodities, currencies, interest rates, market indexes

4. Derivatives used to:

· Hedge risks

· Speculate (take a view on the future direction of the market)

· Lock in an arbitrage profit

· Change the nature of an investment without incurring the costs of selling one portfolio and buying another

Types of traders

1. Hedgers: they use derivatives to reduce the risk that they face from potential future movements in a market variable

2. Speculators: they use derivatives to bet in the future direction of a market variable

3. Arbitrageurs: – they take offsetting positions in two or more instruments to lock in a profit

4. Some of the largest trading losses in derivatives have occurred because individuals who had a mandate to be hedgers or arbitrageurs switched to being speculators

Hedging

1. What is hedging?

· Is engaging in a financial transaction that reduces or eliminates risk

· Offsets a long position by taking an additional short position, or offsets a short position by taking additional long position

2. Long position – an asset which is purchased or owned

3. Short position – an asset which must be delivered to a third party at a future date or an asset which is borrowed and sold but must be replaced in the future

Forward contract

1. A forward contract is a private agreement between two parties made “over the counter”

2. Is a kind of private contracts (derivatives can also be traded as private contracts)

3. A contract can be written however the parties want, it can be customized in terms of size and delivery date

4. A forward contract Is hard to be resold, so the investor has to wait for the delivery date to realize the profit or loss on the position

5. Margins deposited as guarantee, if any, are set once, on the day of the initial transaction

Forward markets: pro and contra

Pros

· Flexible

Cons

· Lack of liquidity: hard to find a counter-party and thin or non-existent secondary market

· Subject to default risk – requires information to screen good from bad risk

Futures contract

1. Is a kind of an organized exchange (derivatives can also be traded as an organized exchange)

2. A futures contract is an agreement to buy or sell an asset at a certain time in the future for a certain price

· Futures markets were originally developed to meet the needs of farmers and merchants

3. Futures contracts are traded on an organized futures exchange

4. Futures contracts are standardized

5. There is usually no money exchanged when the contract is signed, but a margin is deposited as guarantee

· Margins are set by the exchange, subject to periodic revision

6. The standardization of futures contracts takes several forms:

· Day or days of delivery are set standard

· The contract size is fixed

· The quality of the commodity (if the contract relates to a non-financial good) is limited to a specified one of a number of possible alternatives

· The delivery location is specified

Дата добавления: 2015-11-14