Futures and Forwards

Question 1

what four things must be specified in a future or forward contract

Answer 1

1. what you are buying or selling (the underlying)
2. whether you will buy or sell it (long or short)
3. when you will buy or sell it (forward date)
4. at what price (forward price)

Question 2

what is the forward date

Answer 2

specified date of buying or selling in the forward agreemen

Question 3

what is the spot price

Answer 3

where something is trading at today right now

Question 4

how are most forwards and futures settled

Answer 4

cash

Question 5

slope of long position in forward

Answer 5

positive

Question 6

slope of short position in forward

Answer 6

negative

Question 7

how is breakeven price determined

Answer 7

by supply and demand, market expectations

Question 8

what does the bank do with the exposure they take on

Answer 8

find someone on the other side of the bet who has the opposite exposure they would like to spread.

Match the risk

Question 9

why might an investor use a future or forward for an illiquid asset

Answer 9

selling is hard as illiquid

if the risk will not be long term it is easier to just hedge the risk

Question 10

why do some investors trade in futures instead of the underlying

Answer 10

• more liquidity, lower transaction costs
• gains exposure to what otherwise isn’t available
• leverage

Question 11

where are futures traded

Answer 11

over the counter

Question 12

where are forwards traded

Answer 12

on exchanges

Question 13

what is the difference between futures and forwards

Answer 13

forwards are customised, futures are standardised

Question 14

how are forwards customised

Answer 14

private agreement between two parties

specify conditions (price, forward date, amounts)

Question 15

how are futures standardised

Answer 15

terms and conditions pre made. A finite number o contracts traded on the exchange so you must pick between these predetermined dates and prices etc

Question 16

who uses forwards

Answer 16

hedgers who may want to specify their own underlying for something there is not a contract for, or determine their own prices

Question 17

who uses futures

Answer 17

speculators

Question 18

why choose futures over forwards

Answer 18

cheaper to use as less transaction costs

easier to buy and sell

less credit risk

Question 19

why do forwards have more credit risk

Answer 19

the full settlement is agreed with the bank or whoever took on the derivative

so if this bank goes bust, no money will be paid out

so eliminating exposure risk but increasing credit risk

Question 20

what is the credit risk associated with a future

Answer 20

virtually none

you put in a certain amount of money at the start and if this doesn’t cover the worst expected losses, the bank will ring you up to pay

other than this, if you gain money, you can take it out whenevr

Question 21

what is the margin always equal to in future contract

Answer 21

maximum predicted one day loss

Question 22

how often is margin calculated

Answer 22

daily