Chapter 15- Commodities and Financial Futures Flashcards Preview

Investment Management > Chapter 15- Commodities and Financial Futures > Flashcards

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

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


Futures Market


- the organized market for the trading of futures contracts



Futures Contract:

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


Purpose of Futures Market-

- Price Discovery
- Risk Bearing/Sharing



Futures Participants


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



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


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


Disadvantages of Futures Contract:

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


Options vs. Futures Contract


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


Options vs. Futures Contract


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


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


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



Factors in commodity price behavior

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


Components of a Commodities Contract

- the product

- the exchange

- size of the contract

- pricing units

- the delivery months


Factors in Commodity Price Behavior

Weather and crop forecasts
Economic factors
Political factors
International pressures


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


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


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


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


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