Chapter 15- Commodities and Financial Futures Flashcards Preview

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Flashcards in Chapter 15- Commodities and Financial Futures Deck (21):
1


Cash Market


- a market where a product or commodity changes hand s in exchange for a cash price paid when the transaction is completed
       - takes place on location, not an exchange

2


Futures Market

 

- the organized market for the trading of futures contracts

 

3


Futures Contract:

a commitment to deliver a certain amount of some specified item at some specified date in the future at a negotiated price

4


Purpose of Futures Market-


- Price Discovery
- Risk Bearing/Sharing

 

5


Futures Participants

 


- Speculators: 80 to 90% of them lose money
- Hedgers: Users of the product or producers of the product

 

6


Futures Exchanges

 


- US exchanges use electronic trading and open cry auction"
       - futures are mostly electronic
       - options are mostly open outcry
- the exchange serves to guarantee the credibility of the parties involved

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Advantages of using a Futures Contract:


- potential for very high returns
- margin buying allows use of leverage ( the ability to obtain a given equity position at a reduced capital investment, thereby magnifying total return
- allows producers to hedge prices
       - don't have to sell crops at harvest time when prices are often low

8


Disadvantages of Futures Contract:

- high risk of losing more than the amount originally invested; no limit on exposure to loss

9


Options vs. Futures Contract

(Options)

- right to buy
- strike price specified in option contract
- loss limited to price paid for option

10


Options vs. Futures Contract

(Futures)`


Obligation to buy
Delivery price set by supply and demand
No limit on potential loss

11


Trading Mechanics:


- bought and sold through brokerage offices
- same types of orders are used as stocks
       - market
       - limit
- long position- buying a contract
       - investor wants contract price to go up
- short position- selling a contract
       - investor wants contract price to go down
- long and short positions can be liquidated by executing and offsetting transaction
       - about 1-4% of futures contracts are settled

12


Margin Trading:


- all futures contracts are traded on margin
- initial margin deposit is the
       amount deposited with broker at time of commodity transaction to cover any loss in market value of futures contract due to price movements- usually $10- 20,000 to open an account
       - margin requirements range from 2- 10%
- maintenance deposit
       - minimum amount of deposit requires at all times
       - margin call occurs if value drops below  allowed amount
- mark- to- the- market occurs daily

 

13


Factors in commodity price behavior

- weather and crop forecasts
- economic factors
- Political factors
- international pressures

14


Components of a Commodities Contract


- the product

- the exchange

- size of the contract

- pricing units

- the delivery months

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Factors in Commodity Price Behavior


Weather and crop forecasts
Economic factors
Political factors
International pressures

16

Commodity Price Behavior


- Because of leverage, small unit price changes can cause large total dollar changes in contract price

- To protect investors, daily price change limits are set:

Daily price limit: restriction on the day-to-day change in price

Maximum daily price range: the amount a commodity price can change during the day; usually equal to twice the daily price limit

17


Financial Futures:


future contract in which the commodity is a financial asset, such as debt securities, foreign currencies or market baskets of common stocks

- often used by large institutional investors to hedge specific types of risk:
       - offset interest rate risk on debt instruments
       - minimize foreign currency rate risk on overseas business transactions
       - minimize market risk on common stock investments
 

18


Speculating in Financial Futures


- leverage can provide high returns (or losses) enhances chance of return.
- "long" positions are used if investor speculates values will go up
- "short" positions are used if investor speculates values will go down

19


Hedging with Financial Futures


- Effective Way of protecting stock or other securities holdings in a declining market
- stock-index futures used to hedge stock portfolios
- interest rate futures used to hedge bond portfolios
- foreign currency futures used to hedge significant exposure to foreign exchange rate risk

20

Penny Stocks:

Trade at or under $5 a share
- less than $4 million in net tangible assets
- some are "legit"
- shell companies that do not provide a lot of information about what they do

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