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The Derivatives Market > Futures > Flashcards

Futures Flashcards

1
Q

Future contract

A

A contractual obligation in terms of which one party to the deal undertakes on T+0 to sell an asset at a price (determined on T+0) on a future date, and the other party undertakes to buy the same asset at the same price at the same price on the same future date.

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2
Q

Extended definition of a future contract

A

A standardized contract which obligates the buyer to accept delivery of, and the seller to deliver, a standardized quantity and quality of an asset at a pre-specified price on a pre-stipulated date in the future.

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3
Q

Expiry date

A

Date when delivery or cash settlement takes place.

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4
Q

Initial margin

A

A deposit required on futures deals that will ensure that the obligations under the contracts will be fulfilled.

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5
Q

Open interest

A

The number of outstanding contracts of a particular contract.
The number of contracts that are still open and obligated to deliver.

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6
Q

Convergence

A

As time in the life of a future goes by, the future price and the fair value price of the future converge on the spot price, and they are equal on the expiry date of the future.

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7
Q

Basis

A

Difference between the spot price and the future price.

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8
Q

Cost of carry

A

Difference between the fair value price and the spot price.

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9
Q

Participants in the futures market according to functionality

A
  • Investors
  • Arbitrageurs
  • Hedgers
  • Speculators
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10
Q

Investors

A

Investors in the futures market are those that view the futures market as an alternative to the cash market.

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11
Q

Arbitrageurs

A

Endeavour to profit from price differentials that exist in different markets on similar securities.

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12
Q

Role of arbitrageurs

A

They ensure that futures prices do not stray too far from the fair value prices an they add liquidity to the market.

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13
Q

Hedgers

A

Those are the participants that have exposure in the cash market and wish to reduce risk by taking the opposite position in the futures market.
Hedgers transfer risk to speculators.

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14
Q

Speculators

A

Those are the participants that endeavor to gain from the price movements in the futures market.

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15
Q

Hedging

A

The transferring of risk from the hedger (who has a portfolio or is awaiting a certain sum of cash), to some other party in the market (usually another hedger or a speculator).

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16
Q

Micro hedging

A

Each item on the balance sheet is valued separately and an autonomous hedge is set up for each item.

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17
Q

Macro hedging

A

The aggregate asset and/or liability portfolios are considered, and the overall risk is hedged in one operation.

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18
Q

Hedging horizon

A

A date on which the hedge will end.

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19
Q

Anticipatory hedge

A

Hedging a cash/spot position net yet taken.

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20
Q

Cash hedge

A

Hedging an existing position in the cash/spot market.

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21
Q

Long Hedge

A

Buying futures.

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22
Q

Short hedge

A

The hedger sells future contracts.

23
Q

Hedge ratio

A

The number of futures contracts to buy/sell for a given position in the cash market.

24
Q

Basis trading

A

A trading tactic consisting usually of the purchase of a security and the sale of a futures contract with the same underlying security.

25
Q

Motivation for basis trading

A

The speculator/arbitrageurs is of the opinion that the two securities are mispriced in respect to each other, and that the mispricing will correct itself at some stage in the near future, or that a profit will occur upon expiry of the contract.

26
Q

Spread

A

The difference between the prices of two similar of related securities

27
Q

Spread trade

A
  • Has 2 legs
  • Executed simultaneously as a unit
  • The purchase of one security and the sale of a similar or related security.
28
Q

Motivation for a spread trade

A

An expected change in the spread over time.

29
Q

Intra-market spreads

A

The spread is undertaken in the same market but in different maturities.
Also called a calendar spread.

30
Q

Selling the spread

A

Sale of an distant contract and purchase of a nearby contract.

31
Q

Buying the spread

A

Sale of an nearby contract, and purchase of a distant contract.

32
Q

Inter-market spread

A

A trade is undertaken in different but related assets.

33
Q

Futures can be bought and sold in the secondary market like NCDs or treasury bills. True or false?

A

False. Futures are only marketable in the sense that they can be “closed out” by undertaking an opposite transaction.

34
Q

A futures exchange is a “marketplace” where buyers and sellers can “find” each other to enter into a futures contract. True or false?

A

False. Even though a client may buy a future from, or sell a future to, a member of the exchange, the transaction is guaranteed by the exchange, i.e. the exchange acts as the seller for each buyer, and as the buyer for each seller.

35
Q

In practice the delivery of the underlying asset on the expiry date of a futures contract is rare, particularly in the financial futures markets. True or false?

A

True

36
Q

At the start of a futures deal the “initial margin” deposit that has to be paid at the start of a futures deal is set at a level that essentially protects the exchange from default because it is extremely unlikely that losses on positions will exceed the initial margin. True or false?

A

True

37
Q

A future will always trade at a value above the spot price of the underlying asset up to the expiry date, when the two values will be the same. True or false?

A

False. At times the future can trade at a discount to the spot price.

38
Q

In South Africa settlement of a financial futures contract can only be done in cash. True or false?

A

False. In the financial futures markets, physical delivery also takes place in some cases (for example, certain of the bond contracts), but in the majority of cases settlement takes place in the form of cash settlement.

39
Q

The fair value price of a short-term interest rate future cannot be calculated without an implied forward rate. True or false?

A

True

40
Q

The fair value price of a bond future is its clean price less the applicable interest factor. True or false?

A

False

41
Q

What is the relationship between a futures contract on the one hand and specific and notional assets on the other?

A

A futures contract is a derivative instrument, i.e. it and its value are derived from an underlying asset and it cannot exist in the absence of this asset. The underlying assets of futures contracts can be divided into two broad categories, i.e. specific assets and notional assets. Specific (also called “physical”) assets include the R153 bond, pork bellies, etc., while notional assets include the industrial index, the all share index, the gold index, etc

42
Q

An investor bought an index future on 5 September with an expiry date of 30 September. The trading price was 7535. The value of a contract was R10 times index value and the investor bought 5 contracts at a total transaction cost (commission) of R50. On 30 September the index value was 7685. What was the total profit (+) or loss (–) to the investor?

A

R7 450 {[(7685 – 7535) x R10 x 5] – 50}.

43
Q

What is a “short sale”?

A

“Short” sale means the sale of an instrument that the seller does not own. The seller borrows the instrument from an investor / lender for a fee and delivers it back to the lender when the short sale is unwound by the purchase of the instrument. A short sale is undertaken to profit opportunistically from an expected decline in price.

44
Q

Why are members of the futures exchange referred to generically as “broker-dealers”?

A

Members of the futures exchange are referred to by the generic term broker-dealers, because they may deal as principals or agents (in dual capacity). Some broker-dealers do not have clients and only deal as principals, and some broker-dealers deal only as agents with clients (both are called single capacity)

45
Q

Why is each futures contract “valued” at the end of every working day?

A

The purpose of the marking to market is to ensure that the margin account is kept funded. If the mark-to-market price is lower that the purchase price, i.e. if the holder of a future is making a loss, s/he has to top up the margin account to the proportionate level it was. This amount is called the variation margin. If a holder makes a profit, a credit to the margin account is made. The ultimate purpose is to ensure that the exchange, which has taken on the risk of guaranteeing the trades, is protected.

46
Q

Define “open interest” in the futures market.

A

“Open interest” is the term for the number of outstanding contracts, i.e. contracts that are still open and obligated to be delivered (physical or cash settlement). Double counting is avoided in the number. If broker/dealer A takes a position in a future and B takes the opposite position,
open interest is equal to 1.

47
Q

Given the following information, what is the fair value price of an index future?
• Spot price (SP) = 5375
• risk free rate (rfr) (assumed) = 12.5% pa
• assumed dividend yield = 2.1% pa
• term to maturity of contract = 320 / 365.

A

5865 {5375 x {1 + [(0.125 – 0.021) x (320 / 365)]}}

48
Q

The rate now (spot rate) for three months (91 days) is 7.9% pa, the rate now (spot rate) for six months (182 days) is 8.2% pa, and the rate now for nine months (273 days) is 8.7% pa. What is the implied forward rate for six months?

A

8.92% pa {{[1+(0.087 x 273/365)]/[1+(0.079 x 91/365)] –1} x [365/(273 – 91)]}.

49
Q

The rate / price of a 3-month JIBAR interest rate future was 8.89% on the date the contract (nominal value R100 000) was purchased. On the expiry date the rate / price of this future is 7.66%. How much will the exchange pay the client as settlement?

A

R307.50 (R2.50 per basis point)

50
Q

You have the following information:
- Bond (a fictitious bond) = R123
- Maturity date = 15 September 2035
- Coupon (c) = 13.5% pa
- Coupon payment dates (cd1 and cd2) = 15 March and 15 September
- Yield to maturity (ytm) = 8.2%
- rfr = 7.5% pa
- Purchase (valuation) date of future (fvd) = 16 July
-Termination date of future (ftd) = 16 October
- Books (register) close/s = one month before coupon dates
If the dirty price of the bond is 105.71077, what is the fair value price of the futures contact?

A

105.71077 (=A)
+ 1.99793 {A x {(rfr / 100) x [(ftd – fvd) / 365]}}
- 6.79300 {(c / 2) x (1 + {(rfr / 100) x [(ftd – cd2) / 365)]})}
= 100.91570

51
Q

You are given the following information regarding an ALSI future:
• SP (i.e. index value) = 11232
• rfr = 8.5% pa
• I (dividend yield, assumed) = 3.5% pa
• t (number of days to expiry of contract / 365) = 132 / 365
What is the fair value price of this future?

A

11435 {11232 x {1 + [(0.085 – 0.035) x (132 / 365)]}}

52
Q

Summarise the concepts of “cost of carry “ (CC) and “basis” (B) in one equation that gives the fair value price (FVP) in terms of the spot price (SP) and these two concepts.

A

FVP = SP + B + (CC – B)

53
Q

A spread is the difference between the prices of two similar or related securities. True or false?

A

True

The Derivatives Market (7 decks)

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