Futures Citibank

Futures November 1999

Futures

Warning This workbook is the product of, and copyrighted by, Citibank N.A. It is solely for the internal use of Citibank, N.A., and may not be used for any other purpose. It is unlawful to reproduce the contents of this material, in whole or in part, by any method, printed, electronic, or otherwise; or to disseminate or sell the same without the prior written consent of Global Corporate & Investment Bank Training and Development (GCIB T&D) – Latin America, Asia/Pacific and CEEMEA. Please sign your name in the space below.

Table of Contents

TABLE OF CONTENTS Introduction Course Overview........................................................................................

v

Course Objectives......................................................................................

v

The Workbook ............................................................................................

vi

Unit 1: Fundamentals of Futures Introduction.................................................................................................. 1-1 Unit Objectives............................................................................................ 1-1 Development of Futures Contracts........................................................... 1-1 Forward Contracts .............................................................................. 1-1 The Need to Reduce Credit Risk ..................................................... 1-2 Contract Characteristics..................................................................... 1-4 Closing Out a Position........................................................................ 1-6 Participation in the Futures Market ................................................... 1-7 Summary ..................................................................................................... 1-7 Progress Check 1 ...................................................................................... 1-9

Unit 2: Futures Markets - The Key Players Introduction.................................................................................................. 2-1 Unit Objectives............................................................................................ 2-1 The Players ................................................................................................. 2-1 Types of Traders ................................................................................. 2-1 Speculators ............................................................................. 2-1 Arbitragers ............................................................................... 2-2 Locals....................................................................................... 2-2 Hedgers ................................................................................... 2-2 Participation in the Futures Market ................................................... 2-3 Trading for Profit..................................................................... 2-3 Trading to Reduce Risk......................................................... 2-3 v11/02/99 p01/24/00

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TABLE OF CONTENTS

Unit 2: Futures Markets - The Key Players (Continued) Hedging Strategies .................................................................................... 2-3 Risk Reduction .................................................................................... 2-3 Hedging versus Speculating .............................................................. 2-5 Summary ..................................................................................................... 2-6 Progress Check 2 ...................................................................................... 2-7

Unit 3: Futures Market Prices Introduction.................................................................................................. 3-1 Unit Objectives............................................................................................ 3-1 Market Awareness ..................................................................................... 3-1 Pricing.......................................................................................................... 3-6 The “Underlying” .................................................................................. 3-6 Futures Contract Price vs. Cash Market Price ................................ 3-6 Margin Payments........................................................................................ 3-8 Summary ..................................................................................................... 3-9 Progress Check 3 ...................................................................................... 3-11

Unit 4: Interest-rate Futures Introduction.................................................................................................. 4-1 Unit Objectives............................................................................................ 4-1 Major Types of Interest-rate Futures Contracts ....................................... 4-1 Cash-settled Futures Contracts......................................................... 4-2 Deliverable Contract ........................................................................... 4-3 Using Interest-rate Futures to Hedge Interest-rate Risk ......................... 4-4 Additional Considerations When Hedging with Futures.......................................................................................... 4-6 Who Should Use Futures for Hedging? ............................................ 4-8 Summary ..................................................................................................... 4-10 Progress Check 4 ...................................................................................... 4-13

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TABLE OF CONTENTS

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Unit 5: Currency Futures Introduction..................................................................................................5-1 Unit Objectives............................................................................................5-1 Currency Futures Contracts.......................................................................5-1 Contract Features ...............................................................................5-2 Hedging with Currency Futures.................................................................5-4 Summary .....................................................................................................5-5 Progress Check 5 ......................................................................................5-9

Appendices Appendix A: The Mechanics of Futures Markets ....................................A-1 Appendix B: ISO Codes ............................................................................B-1 Appendix C: Financial Derivatives Exchanges’ Websites ....................C-1

Glossaries English.........................................................................................................G-1 Spanish........................................................................................................G-5

Index

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TABLE OF CONTENTS

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Introduction

INTRODUCTION: FUTURES COURSE OVERVIEW In the first course of this workbook, Interest-Rate Forwards, you learned about Forward Rate Agreements (FRAs), their structure, and the many ways that banks and their customers can benefit from their use. You are now ready to move on to this course on Futures. The major futures organization within Citicorp is the Citicorp Futures Corporation (CFC). The CFC provides brokerage to investment bank customers in interest rate, currency, and precious metals. In order to provide superior service to our customers, the CFC must: n

Provide technical knowledge and market expertise essential to the development of effective hedging and trading strategies

n

Create new futures products such as stock index futures

n

Participate in exchanges in many different countries

n

Explain how and why futures contracts differ from forward agreements

Many units of Citicorp are major users of futures contracts. They purchase and sell futures contracts in order to hedge price risks resulting from customer business. In the five units of this workbook, you will be introduced to futures, including the benefits of futures contracts, as well as the limitations of futures contracts.

COURSE OBJECTIVES When you complete this workbook, you will be able to: n

Describe a futures transaction

n

Interpret a newspaper report of futures trading

n

Explain how futures contracts differ from forward contracts

n

Determine whether futures or forwards would be preferrable for a given counterparty

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INTRODUCTION

THE WORKBOOK This self-instruction workbook is designed to give you complete control over your own learning. The material is divided into workable sections, each containing everything you need to master the content. You can move through the workbook at your own pace and go back to review ideas that you didn't completely understand the first time. Each unit contains:

þ

Unit Objectives –

which point out important elements in the unit that you are expected to learn.

Text –

which is the "heart" of the workbook. This section explains the content in detail.

Key Terms –

which also appear in the Glossary. They appear in bold face the first time they appear in the text.

Instructional Mapping –

terms or phrases in the left margin which highlight significant points in the lesson.

Progress Checks –

help you practice what you have learned and check your progress. Appropriate questions or problems are presented at the end of each unit. You will not be graded on these by anyone else; they are to help you evaluate your progress. Each set of questions is followed by an Answer Key. If you have an incorrect answer, we encourage you to review the corresponding text, then try the question again.

In addition to these unit elements, the workbook includes the: Appendices – which present related information for interested Glossary

readers.

– which contains definitions of all key terms used in the

workbook. Index

– which helps you locate the glossary item in the workbook.

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INTRODUCTION

ix

Each unit covers some aspect of futures trading. The units are: n

UNIT 1 – Fundamentals of Futures

n

UNIT 2 – Futures Markets - The Key Players

n

UNIT 3 – Futures Market Prices

n

UNIT 4 – Interest-rate Futures

n

UNIT 5 – Currency Futures

Since this is a self-instructional course, your progress will not be supervised. We expect you to complete the course to the best of your ability and at your own speed. Now that you know what to expect, you are are ready to begin. Please turn to Unit 1. Good Luck!

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INTRODUCTION

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Unit 1

UNIT 1: FUNDAMENTALS OF FUTURES INTRODUCTION Futures transactions have increased substantially in the past 20 years. Futures and interest-rate forwards share some common characteristics, but they differ in other important ways. In this unit, you will learn how futures contracts are structured and used, and how they differ from interest-rate forwards. This unit will provide a foundation for your study of futures markets in following units.

UNIT OBJECTIVES When you complete this unit, you will be able to: n

n n

Recognize the relationship between a futures contract and a forward contract Identify the three requirements for creating a futures contract Recognize the alternatives available to buyers and sellers for closing a position

DEVELOPMENT OF FUTURES CONTRACTS

Forward Contracts Forward contracts have been used for centuries to facilitate future delivery of many commodities around the world. These contracts are agreements which legally bind a party to buy or sell a specific quantity of a well-defined asset at a well-defined time in the future. The delivery of the asset can either be specified for a particular date, or within a particular short period of time. In the past 20 years, the application of forward contracts has expanded to include financial instruments.

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FUNDAMENTALS OF FUTURES

The Need to Reduce Credit Risk Collateralized forward contracts

Traditional forward contracts were established between trusted counterparties, and each accepted the risk that the other might default. With other counterparties collateralized, forward contracts were used to mitigate credit risk. One party (usually the buyer) would place some liquid asset (usually currency) with the other to guarantee performance. Often, the seller could use the collateral to obtain bank financing to cover the cost of producing the commodity sold.

Dualcollateralized forward contracts

Eventually, the question of performance was raised on both sides of the transaction. Of course, it made little sense for two parties to hand each other the same amount of collateral, since a default on the agreement would involve a loss of the collateral placed by the non-defaulting party as well. The solution was to place the collateral with an intermediary, creating dualcollateralized forward contracts.

Mitigate price risk

The amount of the parties' collateral had to cover both the credit risk and the financial risk (the price risk) of non-performance. With long-term agreements, this price risk could be quite large, and the collateral equally as large. To reduce the amount of the initial collateral deposit, long-term dual-collateralized agreements called for periodic payments to cover price changes during the agreement's term.

Example

For example, suppose that a three-year agreement states that if a price movement occurs during any month, the adversely affected party will be required to make an additional collateral contribution. In this case, the initial collateral only has to cover the price risk for one month, not the entire three years.

Marked-tomarket margining

This process of comparing the forward contract rate to current market conditions and determining accrued profit or loss is called marking-to-market. The amount of collateral which is periodically modified according to the mark-to-market process is called margin. With more frequent marked-to-market margining, less initial collateral is required.

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Third-party guarantee

To reduce credit risk to a minimum, daily margining (or even more frequently) has become a common practice. In addition, if the mark-to-market margin is always in cash, and passed from the loser to the gainer, then performance risk is very low. If the third party holding the initial collateral adds a financial guarantee, it effectively removes the credit risk of the counterparty and replaces it with a well-collateralized credit risk of an intermediary.

Offsetting transactions

Counterparties who regularly deal in forward contracts can further reduce the amount of initial collateral by offsetting the price risk with two different forward transactions. Properly structured, these agreements allow the first party to reduce its collateral with an intermediary whenever the price risk is reduced with two positions that offset each other.

Standard agreements

To increase the likelihood that two agreements have the same offsetting price risk, standard agreements are written with the help of an intermediary. In these agreements, the only negotiable issue is the price; all other terms are defined. From the perspective of an intermediary holding the collateral, it doesn't matter who the counterparty is. Thus, offsetting positions held by any one party are netted and removed from the books. If an intermediary is intimately involved in the writing of the agreements used, and then guarantees financial performance, it might just as well become the offsetting counterparty to every transaction. For example, if Party A agrees to buy at a price of 90 from Party B, then the intermediary can just as easily agree to buy at a price of 90 from Party B and sell at a price of 90 to Party A.

Futures contracts

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When forward contracts are written in a standardized manner with: n

an initial collateralization;

n

mark-to-market margining;

n

a publicly-regulated third party as counterparty in every matched trade, allowing the netting of offsetting exposures, the result is called a futures contract.

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FUNDAMENTALS OF FUTURES

This third party is comprised of a futures exchange for rulemaking and trading, and a clearinghouse for settlement and administrative duties. The initial collateral is known as an initial margin deposit. Contract Characteristics Comparison: three types of contracts

Before we discuss the characteristics of futures contracts, let’s review the difference between a cash contract, a forward contract, and a futures contract. A cash contract is similar to any sight purchase: delivery is immediate in exchange for payment (according to normal delivery procedures). The date of the delivery and payment is often called the spot date. A forward contract establishes an agreed-upon delivery date in the future. Payment is at delivery, or the agreement establishes the parameters for determining a cash settlement on the future date. A futures contract is similar to a forward contract, except that it is standardized, adds mark-to-market margining to reduce credit risk, and is established through an organized exchange.

Forward contract elements

A basic forward contract contains the following information: n

Description of the underlying asset

n

Delivery conditions (including dates)

n

Price

n

Payment conditions

n

Conditions for endorsing to third parties

n

Provision for handling exceptions

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Additional future contract elements

1-5

Futures contracts have all the elements of forward contracts and, additionally, have standardized: n

Quantity

n

Points of delivery

n

Settlement price determination

n

Margining process

These descriptions provide assurance about the quality and quantity of the assets so that trading activities can concentrate on price. Let's look at three examples: Example 1

Yen Futures

Yen futures on the Chicago Mercantile Exchange (CME) specify the delivery of 12.5 million yen on a single maturity date. Example 2

Treasury Bond Futures

U.S. Treasury Bond futures traded at the Chicago Board of Trade (CBT) specify that the T-bonds to be delivered must have 20 years to maturity with at least 15 years to the first potential repayment date. The CBT also supplies a standardized formula to adjust the actual cash paid for each bond so that bonds of different maturities and coupon rates can be compared. (“Coupon” refers to the interest payment on the bond.) The standardized formula makes adjustments to any bond which does not have an 8% coupon (6% coupon 3/2000). Larger coupons are more valuable, and the amount paid for those bonds is appropriately increased. Bonds with coupons below 8% are less valuable, and the amount paid for them is decreased.

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Example 3

FUNDAMENTALS OF FUTURES

Eurodollar Futures

Eurodollar ( ED) futures at the Chicago Mercantile Exchange (CME) mature on the second London business day before the third Wednesday of the month. On that day, the CME uses actual bank lending rates for three-months ( LIBOR) to settle the contract. The final contract settlement price is 100.00 minus 3 month LIBOR (expressed as a percent). The higher the level of LIBOR at final settlement, the lower the price of the ED future. Establishing price

The price of a futures contract is established through free-market bidding and offering. The marketplace may consist of individuals linked through telecommunications and computers, or it may be an actual physical location where potential counterparties see and hear each other. The process of bidding and offering in the physical marketplace is called open outcry. Closing Out a Position

Two alternatives

Offsetting

Buyers and sellers of futures contracts have two alternatives available for closing out a position. 1)

The buyer can accept (or the seller can deliver), the asset on the date specified in the contract, unless the contract is cash settled, in which case the final margin payment closes the position.

2)

The buyer and seller can offset their positions prior to delivery date.

Most futures contracts are offset before the delivery date; buyers seldom take possession of the asset — and sellers seldom deliver the asset. n

Buyers (holders of a long position) offset by selling an identical contract for the same delivery month. Holding a long position means they profit if the futures price of the underlying asset increases.

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n

1-7

Sellers (holders of a short position) offset by buying an identical contract for the same delivery month. Holding a short position means they profit if the futures price of the underlying asset decreases.

In other words, either the buyer or seller can offset a position with another transaction that is opposite (buyers sell and sellers buy) and equal (identical contract and amount). Participation in the Futures Market Standardization increases liquidity

The standardization of contract terms helps to increase the liquidity (volume of trading) in individual futures contracts because parties with similar, though different, positions choose the same futures contract. The strict margining process removes credit risk, which allows for greater participation in the futures market than in the traditional forward market. In addition to the large banks and multi-national corporations that use forward contracts, small companies and individuals that usually cannot use forward contracts can easily participate in the futures market.

SUMMARY In this unit, we focused on the differences between a forward contract and a futures contract. A forward contract is a legally binding commitment to buy or sell — or affect the financial equivalent of buying or selling: n

A specified quantity of an underlying asset

n

On a specified future date

All forward contracts must contain at least the following basic information:

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n

Description of the underlying asset

n

Delivery conditions (including dates)

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FUNDAMENTALS OF FUTURES

n

Price

n

Payment conditions

n

Conditions for endorsing to third parties

n

Provision for handling exceptions

A futures contract has all the elements of a forward contract. In addition, it is standardized, reduces credit risk with mark-tomarket margining, and is established through an organized exchange. A futures contract is usually closed out with offsetting transactions by both parties before the specified future date. Standardization and the reduction in credit risk due to mark-tomarket margining allow for greater diversity of participation in the futures market than in the forward market. You have now completed Unit 1: Fundamentals of Futures. Please answer the questions in the following Progress Check before continuing to the next unit, Futures Markets – The Key Players. If you answer any question incorrectly, you should return to the text and read that section again.

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FUNDAMENTALS OF FUTURES

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þ PROGRESS CHECK 1 Directions: Complete the multiple choice questions by checking the correct answer(s). Compare your answers with the Answer Key on the following page. Question 1: Which definition best describes a futures contract? _____ a) Agreement to buy an asset on a designated future date, at a floating rate _____ b) Standardized contract to buy or sell an asset at a specified price, at some unspecified future time _____ c) Standardized contract to buy or sell an asset at a specified price on a specific future date _____ d) Agreement to sell an asset in the cash market, at a specified price Question 2: The characteristics that differentiate a futures contract from a forward contract are: _____ a) agreed-upon delivery date, mark-to-market margining, and parameters for determining cash settlement. _____ b) standardization, mark-to-market margining, and establishment through an organized exchange. _____ c) immediate delivery in exchange for payment, mark-to-market margining, and standardization. _____ d) payment at delivery, standardization, and establishment through an organized exchange. Question 3: Which statement best describes payment conditions for futures contracts? _____ a) Futures contracts are usually canceled before delivery date; therefore, no money is paid. _____ b) Seller pays an initial margin deposit to assure the buyer that s/he can deliver on the futures contract. _____ c) Buyer pays an initial margin deposit to assure the seller that s/he will take delivery of the asset. _____ d) The seller and the buyer pay initial margin deposits to show they are both able to fulfill the contract.

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FUNDAMENTALS OF FUTURES

ANSWER KEY

Question 1: Which definition best describes a futures contract? c) Standardized contract to buy or sell an asset at a specified price on a specific future date Question 2: The characteristics that differentiate a futures contract from a forward contract are: b) standardization, mark-to-market margining, and establishment through an organized exchange. Question 3: Which statement best describes payment conditions for futures contracts? d) The seller and the buyer pay initial margin deposits to show they are both able to fulfill the contract.

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PROGRESS CHECK 1 (Continued)

Question 4: What does it mean to offset a futures contract? _____ a) Before the delivery date, another transaction is concluded with an identical but opposite futures contract. _____ b) Futures contracts are bought by another party. _____ c) Delivery of the underlying financial instrument takes place one week before the specified date. _____ d) Before the delivery date, another transaction is concluded which is exactly the same. Question 5: Select two alternatives that futures buyers have for closing out their position. _____ a) They can offset their position by buying an identical contract for the same delivery month. _____ b) They can offset their position by selling an identical contract for the same delivery month. _____ c) They can take delivery of the assets. _____ d) They can deliver the assets. Question 6: Indicate two alternatives that futures sellers have for closing out their position. _____ a) They can offset their position by buying an identical contract for the same delivery month. _____ b) They can offset their position by selling an identical contract for the same delivery month. _____ c) They can take delivery of the assets. _____ d) They can deliver the assets.

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FUNDAMENTALS OF FUTURES

ANSWER KEY

Question 4: What does it mean to offset a futures contract? a) Before the delivery date, another transaction is concluded with an identical but opposite futures contract. Question 5: Select two alternatives that futures buyers have for closing out their position. b) They can offset their position by selling an identical contract for the same delivery month. c) They can take delivery of the assets. Question 6: Indicate two alternatives that futures sellers have for closing out their position. a) They can offset their position by buying an identical contract for the same delivery month. d) They can deliver the assets.

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Unit 2

UNIT 2: FUTURES MARKETS – THE KEY PLAYERS

INTRODUCTION Now that you are familiar with the fundamentals of futures, let's see how the futures markets operate. Why do traders engage in futures transactions? How do corporations use futures to improve and safeguard their assets? These two questions will be answered in this unit. In addition, you'll learn how hedging is used to reduce risk.

UNIT OBJECTIVES When you complete this unit, you will be able to: n n

Identify and describe three motives for engaging in a futures transaction Recognize how futures can be used to enhance and protect corporate results

THE PLAYERS

Types of Traders Futures markets offer opportunities for four types of traders: speculators, arbitragers, locals, and hedgers.

Speculators Profit opportunity with risk

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A trader who engages in speculation enters into a transaction because it offers the opportunity for a large profit. At the same time, however, it offers the possibility of a big loss.

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FUTURES MARKETS – THE KEY PLAYERS

Speculators trade futures to gain leverage, which is the potential for profit without substantial capital commitment. For a margin deposit of 10%, an unanticipated 5% increase in the futures market results in a return on capital of 50% (less transaction costs). Of course there is also the possibility that futures prices may decline and cause a loss for the trader. Arbitragers Play one market against another

A trader who engages in arbitrage attempts to profit by simultaneously purchasing and selling closely-related instruments in different markets. Arbitragers play one market against another, looking for a product that is overvalued in one market relative to the other. They buy where it is undervalued, sell where it is overvalued, and make a profit if the differential exceeds transaction and carrying costs (the cost of arbitrage). Locals Locals are traders working on the floor of an exchange who engage in speculation and arbitrage for their own accounts. Local traders hope to profit from the minute-by-minute flow of futures transactions. Hedgers

Offsetting risk in current position

Hedging is the purchase or sale of financial instruments with the objective of protecting overall results by offsetting the risk inherent in a current position. This hedge may change a variable rate to a fixed rate or the opposite. It may "lock-in" or "fix" a loss, or it may "lock-in" or "fix" a profit. Hedging to lock-in a loss is advisable when changes in market conditions are likely to result in greater losses. In some hedging transactions, especially in the commodities markets, hedgers anticipate the future need for a product, act to preset a favorable price, guarantee supply or demand, and protect themselves against possible losses. They buy or sell futures contracts that serve as substitutes for later positions in a physical market in order to reduce risk.

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Participation in the Futures Market Traders participate in the futures market either to make a profit or to reduce risk. Trading for Profit Speculators and arbitragers

Both speculators and arbitragers (including locals) attempt to profit by seeking trading opportunities that offer large returns. However, each works in a different way: n

The speculator assumes a large amount of risk for the possibility of equally large returns.

n

The arbitrager looks for market inefficiencies to make a profit.

You can say that speculators help launch markets — and arbitragers make them more efficient. Both speculators and arbitragers add to the liquidity of the market. Trading to Reduce Risk Hedgers

In contrast, hedgers seek to reduce risk inherent in their business by locking in returns on investments, fixing costs, and guaranteeing the future supply of currencies and commodities required for their operations. Corporations usually trade in the futures market as hedgers. Now that we have examined the four types of traders and their motives, let's move to the hedging strategies traders use to reduce risk.

HEDGING STRATEGIES

Risk Reduction Requires knowledge about the asset

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The only motivation behind hedging is the reduction of risk. Therefore, hedging requires knowledge about the asset to be delivered and the effect of economic forces on its future and cash markets.

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Examples

FUTURES MARKETS – THE KEY PLAYERS

Let us look at three situations where hedging is used to protect corporate results: 1) A Chief Financial Officer expects interest rates to drop, an effect that has not yet been anticipated by the market. He knows his organization will be receiving USD 10 million three months ahead, which he will invest in Treasury bonds. Since T-bond futures are quoted in USD 100,000 lots, he buys 100 T-bond futures in order to lock in today's futures interest rate. 2) A Japanese exporter of robots will receive USD 1,000,000 in six months. She is worried that the U.S. dollar might fall in value against the Japanese yen. She buys Japanese yen futures contracts, agreeing to pay U.S. dollars in the future and receive yen in the future. This reduces the risk of the U.S. dollar falling in value and the yen rising in value. 3) A corporate treasurer expects floating (variable) interest rates to rise. In order to hedge its floating-rate loan interest cost, the corporation sells Eurodollar futures ( ED). As short-term interest rates rise, the price of the ED futures will fall, and the corporation will receive profit from the futures position. This profit will be used to offset the added interest cost on the loan. These strategies are especially successful if the futures market price is inconsistent with the decision-maker's belief.

Assets that imitate economic trends

Direct mimic

Many corporations that are active in the futures markets look for underlying assets that imitate or mimic trends they either want to take advantage of or protect against. Mimicking can be: n

direct, where the asset closely follows a trend, or

n

inverse, where the asset moves in the opposite direction.

Stock market index futures are direct mimics of overall economic health. If the economy is doing well, they tend to move upward; if the economy is not doing well, they tend to move downward.

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Inverse mimic

2-5

However, when the economy deteriorates, people tend to hoard gold which causes gold prices to rise. This is an inverse mimic of general economic trends because it is contrary to them. Businesses engage in hedging activities because they: n

Require specific quantities of certain assets

n

Recognize that the spot and future prices of certain assets reflect economic realities

n

Want to avoid risk

Therefore, corporations primarily trade in the futures market as a means of protecting and enhancing their business activities — not as a source of revenue. Hedging versus Speculating If a party has no underlying (intrinsic) exposure to the factors which influence a futures contract, then establishing a position with the futures contract is definitely speculation. If a party has an underlying exposure and uses a futures position to reduce the business risk of that underlying exposure, then the process is called hedging. Selective hedging is actually speculating

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Though the distinction may appear clear, in reality it is not clear. Often, text refers to hedging an underlying exposure because the party expects the market conditions to change unfavorably. An example is selling yen in the futures market due to the expected receipt of yen in the future and the expectation of a weakening yen. This selective hedging is actually speculating, since the hedge is only taken based upon the speculation that the yen will weaken. True hedging must be a consistent policy independent of expectations.

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FUTURES MARKETS – THE KEY PLAYERS

SUMMARY There are four types of traders: 1) speculators, 2) arbitragers, 3) locals, and 4) hedgers. Speculators trade futures to gain leverage. Arbitragers simultaneously purchase and sell closely-related instruments in different markets. Locals are speculators and arbitragers who work on the floor of the exchange. Hedgers purchase or sell financial instruments to offset a risk. Although speculators and arbitragers seek substantial returns from their trading, they work in different ways. While the speculator takes large risks, the arbitrager relies on inefficiencies in the market. Hedgers, on the other hand, reduce risk by locking in returns on their investments, fixing costs, and guaranteeing a future supply of currencies and commodities. Corporations and banks often trade as hedgers. Traders hedge to reduce risk. To be successful, they must have knowledge of the asset to be delivered — and also know the effect of economic forces on its future and cash markets. Hedging strategies include locking in a current futures interest rate in anticipation of a drop in interest rates, and locking in a current futures price when a drop in the cash price is expected.

You have now completed Unit 2: Futures Markets – The Key Players. Please complete the following Progress Check before continuing to the next unit, Futures Market Prices. If you answer any question incorrectly, you should return to the text and read that section again.

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þ PROGRESS CHECK 2 Directions: Complete the questions below as directed. Compare your answers with the Answer Key on the following page. Question 1: Three reasons for trading futures are speculation, arbitrage, and hedging. Match each term to its definition. ____Speculation

a)

Offsetting a current or expected position

____Arbitrage

b)

Engaging in risky transactions with the expectation of a large profit

____Hedging

c)

Purchasing and selling closely related assets in different markets at the same time

Select the one best answer in questions 2, 3, 4, 5, and 6. Question 2: Why do speculators enter the futures market? _____ a) It is a very volatile market and requires substantial margin investments. _____ b) Low margin requirements practically guarantee a profit. _____ c) The low margin requirements provide a great deal of leverage. _____ d) It provides leverage that protects against losses.

Question 3: The opportunity for arbitrage occurs when the difference between spot prices and futures prices: _____ a) increases. _____ b) differs from the "cost" of arbitrage. _____ c) decreases.

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FUTURES MARKETS – THE KEY PLAYERS

ANSWER KEY Question 1: Three reasons for trading futures are speculation, arbitrage, and hedging. Match each term to its definition. b Speculation

a)

Offsetting a current or expected position

c Arbitrage

b)

Engaging in risky transactions with the expectation of a large profit

a Hedging

c)

Purchasing and selling closely related assets in different markets at the same time

Question 2: Why do speculators enter the futures market? c) The low margin requirements provide a great deal of leverage. Question 3: The opportunity for arbitrage occurs when the difference between spot prices and futures prices: b) differs from the "cost" of arbitrage.

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2-9

PROGRESS CHECK (Continued) Question 4: What percentage return or loss will a trader realize on a long futures position if s/he deposits initial margin of 10% and the value of the underlying asset goes up 10%? _____ a) 100% loss _____ b) 10% loss _____ c) 100% gain _____ d) 10% gain Question 5: What percentage return or loss will a trader realize on a short futures position if s/he deposits initial margin of 10% and the value of the underlying asset goes up 25%? _____ a) 250% loss _____ b) 250% gain _____ c) 25% loss _____ d) 25% gain Question 6: Which one of the following situations best describes a typical hedging strategy? _____ a) Buying contracts for future delivery that serve as substitutes for later necessary positions in a physical market in order to reduce risk _____ b) Buying contracts for future delivery that do not necessarily represent later necessary positions in a physical market, but might reduce risk _____ c) Buying contracts for future delivery serving as substitutes for later necessary positions in a physical market, but which may or may not reduce risk

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ANSWER KEY Question 4: What percentage return or loss will a trader realize on a long futures position if s/he deposits initial margin of 10% and the value of the underlying asset goes up 10%? c) 100% gain NOTE: The trader with a long futures position is the buyer. Contract price = $1,000 Deposit @ 10% = $100 Increased value of the underlying asset @ 10% = $1,100 On delivery date, buyer receives $1,100 - $1,000 = $100 and has made 100% profit on the $100 deposit.

Question 5: What percentage return or loss will a trader realize on a short futures position if s/he deposits initial margin of 10% and the value of the underlying asset goes up 25%? a) 250% loss NOTE: The trader with a short futures position is the seller. Contract price = $1,000 Deposit @ 10% = $100 Increased value of the underlying asset @ 25% = $1,250 On delivery date seller pays $1,250 - $1,000 = $250 loss or 250% of the $100 deposit .

Question 6: Which one of the following situations best describes a typical hedging strategy? a) Buying contracts for future delivery that serve as substitutes for later necessary positions in a physical market in order to reduce risk

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2-11

PROGRESS CHECK (Continued)

Question 7: Select three primary motives that hedgers have for trading futures contracts. _____ a) Make a profit _____ b) Lock in returns on investments _____ c) Gain leverage _____ d) Preset favorable prices _____ e) Guarantee future supplies

Question 8: You are the Chief Financial Officer of a company in Puerto Rico, the subsidiary of a major Swiss industrial company. Your subsidiary generates US dollars, and your parent company deals in Swiss francs. It is September and your budget reflects that you are committed to remitting a dividend to your parent in December. The market is quoting the following prices:

Spot:

0.4002 (USD per CHF)

Futures (for December delivery): 0.3995

What action should you take in order to guarantee this dividend payment in December? _____ a) Buy spot CHF at 0.4002 USD per CHF _____ b) Sell spot CHF at 0.4002 USD per CHF _____ c) Buy December CHF futures at 0.3995 USD per CHF _____ d) Sell December CHF futures at 0.3995 USD per SFC

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ANSWER KEY Question 7: Select three primary motives that hedgers have for trading futures contracts. b) Lock in returns on investments d) Preset favorable prices e) Guarantee future supplies Question 8: You are the Chief Financial Officer of a company in Puerto Rico, the subsidiary of a major Swiss industrial company. Your subsidiary generates US dollars, and your parent company deals in Swiss francs. It is September and your budget reflects that you are committed to remitting a dividend to your parent in December.

The market is quoting the following prices:

Spot:

0.4002 (USD per CHF)

Futures (for December delivery): 0.3995

What action should you take in order to guarantee this dividend payment in December? c) Buy December CHF futures at 0.3995 USD per CHF NOTE: The dividend will be remitted in December, so buy Swiss francs for December delivery at USD 0.3995.

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Unit 3

UNIT 3: FUTURES MARKET PRICES INTRODUCTION A true understanding of the futures market comes from being knowledgeable about all aspects of futures trading. Although it is important to know how futures are traded, and who is doing the trading, there is another area of equal importance: pricing. In this unit, you will learn about futures market pricing. You will become familiar with pricing data that appears daily in the newspaper and the relationship between prices in the cash and prices in the futures markets. Finally, you will see how margins are defined for futures trading.

UNIT OBJECTIVES When you complete this unit, you will be able to: n

Interpret a newspaper report on futures market transaction data

n

Recognize the relationship between the price of a futures contract and the price of the underlying in the cash market

n

Recognize two types of margin that are required for futures contracts

MARKET AWARENESS Newspaper account of market transactions

In this first section, you will learn how to read a newspaper account of market transactions. You will find out how to identify the contract delivery months, the opening, high, low, and settle prices. You will also read an explanation of the numerical information that is provided. On page 3-2, you will find a reproduction of a section of the Wall Street Journal's report of futures prices for September 1, 1999. Since there are references to that Wall Street Journal reprint throughout this unit, it may be helpful to copy the reprint.

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Please follow the reprint on page 3-2 as you read the explanations of a futures price report. Exchange

Find the section with the heading, INTEREST RATES . You can see that Treasury bond futures are traded at the Chicago Board of Trade ( CBT ) and at the Mid-America Commodities Exchange (MCE).

Contract amount

At the CBT , each contract has a face value of US$100,000. For TREASURY BONDS (MCE), the face value of each contract is US$50,000. You will also notice that they trade in percentages of 100% and 32nds of 1%. US T-bond futures prices are quoted using 32nd because that is the convention for the cash US Tbonds. This is not the case for the bonds of other countries and currencies.

Contract delivery months

The first column on the left shows the contract delivery months.

Prices

To the right of that column are columns that show the opening, high, low, and settle prices for each of the contract months. The settle price is the average price of all trades taking place during the last minute of the trading day. Notice the dash in the middle of the prices. To the left of the dash the numbers are percentages of 100; to the right of the dash the numbers are 32nds of 1%.

Example

The low for September delivery at the CBT was 114-01 or 114 and 1/32nds percent.

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n

Divide 1 by 32 to get 1/32nds expressed decimally 0.03125.

n

Add 0.03125 to 114 percent = 114.03125%.

n

This is a US$100,000 contract at face value, so the dollar value before market opened on 9/1/99 was US$114,031.25.

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FUTURES MARKET PRICES

Looking down the page, you will find EURODOLLAR (CME) – $1 million; pts of 100%. This heading means that the profit or loss on the ED future corresponds closely to the profit or loss on a $1 million forward rate agreement ( FRA), and that the price is expressed in percentage points. You can see that the settlement price for the Sept 99 ED future is 94.44, which is a percentage of $ CME. Moving to the right, the columns show the change between that day's settle price and the previous day's settle price. Next are columns showing the yield and the amount of open interest. Yield settle / yield change

Yield settle, the first yield column, is the interest rate implicit in this future. It is calculated on that day's settle price and takes into consideration all future interest coupons that come with the underlying asset. Yield change shows the increase / decrease compared to the previous trading day. The yield for the ED future is 100 minus price. This yield corresponds to the interest rate on a three-month FRA with a settlement date equal to the futures maturity. As FRA rates rise, ED futures prices fall. A floating-rate borrower could hedge against a rise in interest rates by selling ED futures contracts.

Volume of each futures contract series

The volume (Est vol) of transactions of each series of futures contract is listed at the bottom of its price quotations before total open interest. The estimated volume reported on 9/1/99, in ED futures was 471,744 contracts. This is a huge amount of transaction volume, especially considering that each contract represents a $1 million 3-month FRA. The actual volume from the previous session (Monday) was 271,760 contracts.

Outstanding contracts not offset

Open interest (open int) refers to the number of outstanding contracts that have not yet been offset. It is an indicator of the amount of ongoing interest in this particular market.

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3-5

Notice that the open interest for the Sept 99 ED future is 503,746 contracts. Due to the size of the contract, this corresponds to approximately $500 billion of 3-month FRAs. The total open interest for all ED contract months is listed at the bottom. On this date, it was 3,050,261 which was an increase of 1,005 compared to the previous day. Since each of these contracts represents a $1,000,000 3-month FRA, the total open interest represents approximately $3 trillion of 3-month FRAs. Expressed as annual interest-rate risk, this would be approximately $750 billion. The Wall Street Journal does not provide information about the exact specifications of the underlying assets. These are very clear to the people who trade in these markets. The market concentrates on price and delivery dates. Review the following example that appeared in Unit 1: U.S. Treasury Bond futures traded at the Chicago Board of Trade (CBT ) specify that the T-bonds to be delivered must have 20 years to maturity with at least 15 years to the first potential repayment date. The CBT also supplies a standardized formula to adjust the actual cash paid for each bond so that bonds of different maturities and coupon rates can be compared. The standardized formula makes adjustments to any bond which does not have an 8% coupon, (6% coupon 3/2000), (interest payment). Larger coupons are more valuable, and the amount paid for those bonds is appropriately increased. Bonds with coupons below 8% (6%coupon 2/2000) are less valuable, and the amount paid for them is decreased.

This example contains important information about the exact composition of T-bond futures traded at the CBT which cannot be found in the Wall Street Journal report. Shorthand notation

There is also information which is not clear to the uninitiated. It is a kind of "shorthand notation" that the market has developed to save space in the newspaper. For example, look at the Japanese yen futures quotation on page 3-2. At the end of the first line you see (.00) which means that all prices should be divided by 100. This Convention saves newspaper space because yen are numerically much higher than US dollars (.9050 means that 1 yen equals USD .009050).

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PRICING The “Underlying” Generic term

Before we discuss pricing, it is important to understand that futures contracts may or may not be written on physical commodities. Futures contracts either allow physical delivery of “something” or are written with cash payments based upon “something.” Futures contracts often are written on physical commodities, and the term “underlying commodity,” “underlying asset,” or “the physical” may be used to refer to the “something” on which a futures contract is based. For example, the underlying commodity for a gold futures contract is gold, and the underlying commodity for a wheat futures contract is wheat. Since futures contracts are also written on many different “somethings” which are neither assets nor physical nor commodities (such as smog allowances and interest rates), the generic term “underlying” is commonly used to refer to the “something” on which futures contracts are based. In addition, if the futures contract does not allow immediate delivery, the underlying of the futures contract is a forward such as a gold forward or a wheat forward. In the case of the Eurodollar futures contract, the underlying is an interest rate forward — an FRA. Futures Contract Price vs. Cash Market Price

Cash price

The price of a futures contract is often different from the price of the underlying. The cash price is the amount at which the physical asset is traded based on immediate (or spot) delivery. In a cash market, the buyer pays for the asset and receives it immediately from the seller.

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The relationship between the price of a financial future and the price of the underlying cash market is based upon relevant interest rates, with adjustments for specifications of the contract which benefit either the buyer or the seller (usually the seller). Cost of carry

Other pricing factors

Estimating futures prices

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Several factors interplay to create this relationship. The most important factor is the cost of carry, or how much it costs to hold the asset until delivery date. n

If the asset does not pay interest, the cost of carry is roughly equal to what it would cost to borrow money to hold that asset until delivery, plus storage costs.

n

If the asset is interest-bearing, the cost of carry, as stated above, is reduced by the asset's yield.

n

If the future is quoted in a soft currency (as in a futures exchange in Brazil, for example), the cost of carry also includes the market's aggregate estimate of future inflation or currency devaluation until delivery date (which should be included in the local interest rate, if the financial markets are efficient).

The pricing relationship is also affected by: n

Time until delivery

n

Deliverable supply

n

Cost of delivery (including brokerage, tax, and other transaction costs)

n

Changes in the “underlying” itself, such as coupon payments prior to delivery

n

Price expectations

Since the cost of carry is the primary variable in determining the pricing relationship, it is possible to closely estimate futures prices by knowing the cash price and the cost of carry.

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FUTURES MARKET PRICES

In general, the following guidelines apply: n

If the cost of borrowing money is lower than the face interest of the asset, futures prices tend to be less than the cash price. Also, distant delivery months are priced lower than close delivery months.

n

If the cost of borrowing money is higher than the face interest of the asset, futures prices tend to be higher than the cash price. Distant delivery months are priced higher than close delivery months.

MARGIN PAYMENTS Different from “buying on margin”

Margins on futures contracts should not be confused with margins applied to equity markets. In equity markets, a client buying shares through a broker borrows a portion of the purchase price from the broker. This is called buying on margin. Since futures contracts do not require the outright possession of the asset, there is no need to pay the contract price, or borrow the difference between the contract price and the amount of margin.

Two types of margin

All futures contracts are subject to two types of margin: n

Initial margin deposit

n

Variation margin

As described in Unit 1, both parties in a futures transaction are expected to make an initial margin deposit on a contract. This margin is a good faith deposit to demonstrate that the traders are able to perform on that contract.

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Variation margin is the amount of additional funds a trader must put up if market movements cause the initial deposit to be insufficient (that is, below a level referred to as “maintenance margin”); conversely, if market movements cause a profit, the trader can immediately withdraw the balance beyond the margin requirement. Since futures contracts are settled every day, the holder of a futures position fulfills the margin requirement daily by either depositing margin or withdrawing the balance beyond margin.

SUMMARY Futures market transaction data is reported daily in the newspapers. That information is limited to price, delivery dates, and open interest. Understanding terms such as settle price, yield, and open interest helps you interpret the activity of the market. To have a full understanding of the futures market, you must be familiar with the "shorthand notation" data found in the newspaper. There is a difference between prices in the cash market and prices in the futures market. Several factors combine to create this relationship. They are: n

Cost of carry (most important)

n

Time until delivery

n

Deliverable supply

n

Cost of delivery (including brokerage, tax, and other transaction costs)

n

Changes in the securities themselves

n

Price expectations

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In addition to the initial margin (deposit required to initiate a futures transaction), a futures contract requires a variation margin. That's the amount of additional funds a trader must deposit if market movements make the initial margin insufficient. You have now completed Unit 3: Futures Market Prices. Please complete the following Progress Check before continuing to Unit 4: Interest-Rate Futures. If you answer any question incorrectly, you should go back to the text and read that section again.

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3-11

þ PROGRESS CHECK 3 Directions: Please refer to the WSJ reproduction on page 3-2 and complete the questions below. Compare your answers with the Answer Key on the following page. Question 1: How are yen futures quoted? (Fill in the blanks) Contract size is ___________; quotes are in ___ per ___, multiplied by ______.

Question 2: What is the opening price in USD for: a)

September 1999 Japanese yen? ______________

b)

December 1999 Japanese yen? _______________

Question 3: What is the settle price in USD for: a)

September 1999 Australian dollars? _______________

b)

December 1999 Swiss francs? ________________

Question 4: What is the open interest on:

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a)

September 1999 British pounds?

b)

December 1999 Canadian dollars? ______________ contracts

c)

September 1999 Eurodollars (CME)? ______________ contracts

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FUTURES MARKET PRICES

ANSWER KEY

Question 1: How are yen futures quoted? Contract size is 12.5 million yen; quotes are in USD per JPY, multiplied by 100.

Question 2: What is the opening price in USD for: a)

September 1999 Japanese yen? USD .009050 / JPY

b)

December 1999 Japanese yen? USD .009180 / JPY

Question 3: What is the settle price in USD for: a)

September 1999 Australian dollars? USD .6402 / AUD

b)

December 1999 Swiss francs? USD .6693 / CHF

Question 4: What is the open interest on: a)

September 1999 British pounds? 53,157 contracts

b)

December 1994 Canadian dollars? 4,698 contracts

c)

September 1999 Eurodollars (CME)? 503,746 contracts

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3-13

PROGRESS CHECK 3 (Continued)

Question 5: Complete the following statements by matching Column B to Column A.

Column A

Column B

_____When the cost of borrowing money is less than the face interest return on the asset, the . . .

a)

distant futures delivery months will be priced higher than near-term delivery months.

_____When the cost of borrowing money is more expensive than the face interest return on the asset, the . . .

b)

distant futures delivery months will be priced lower than near-term delivery months.

Question 6: Match the following definitions for cost of carry with the assets to which they refer:

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____ Non interest-bearing assets

a) Cost of borrowing funds to hold the asset until the futures delivery date plus storage costs

____ Interest-bearing assets

b) Difference between the asset's yield and the cost of borrowing funds to hold the asset until the futures delivery date

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ANSWER KEY

Question 5: Complete the following statements by matching Column B to Column A.

Column A

Column B

b

When the cost of borrowing money is less than the face interest return on the asset, the. . .

a)

distant futures delivery months will be priced higher than near-term delivery months.

a

When the cost of borrowing money is more expensive than the face interest return on the asset, the. . .

b)

distant futures delivery months will be priced lower than near-term delivery months.

Question 6: Match the following definitions for cost of carry with the assets to which they refer: a

b

Non interest-bearing assets

Interest-bearing assets

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a)

Cost of borrowing funds to hold the asset until the futures delivery date plus storage costs

b)

Difference between the asset's yield and the cost of borrowing funds to hold the asset until the futures delivery date

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PROGRESS CHECK 3 (Continued)

Question 7: Match each margin type in the first column with its definition in the second column. Initial Margin

a) Amount of additional funds a trader must put up if market movement causes a loss in the value of a position

Variation Margin

b) Deposit which must be put up by a trader to begin a futures transaction

Question 8: Margin in futures trading differs from margin in equity transactions. Identify each of the following statements as either an equity transaction (E) or a futures transaction (F). _____ Margin is the amount of money put up by the trader, with the balance of the total transaction price being loaned to the trader by the broker. _____ Margin is a good faith deposit used to demonstrate a trader's ability to fulfill a contract. Question 9: Profits and losses on futures contracts are usually realized:

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a)

daily.

b)

hourly.

c)

quarterly.

d)

every fifth trading day.

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ANSWER KEY Question 7: Match each margin type in the first column with its definition in the second column. b

Initial Margin

a) Amount of additional funds a trader must put up if market movement causes a loss in the value of a position

a Variation Margin

b) Deposit which must be put up by a trader to begin a futures transaction

Question 8: Margin in futures trading differs from margin in equity transactions. Identify each of the following statements as either an equity transaction (E) or a futures transaction (F). E

Margin is the amount of money put up by the trader, with the balance of the total transaction price being loaned to the trader by the broker.

F

Margin is a good faith deposit used to demonstrate a trader's ability to fulfill a contract.

Question 9: Profits and losses on futures contracts are usually realized: a) daily.

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PROGRESS CHECK 3 (Continued)

Question 10: In order to settle futures contracts, a settle price is determined each day. This price is calculated as the average of all trades for a futures contract during: _____ a) that day. _____ b) the last hour of trading for the day. _____ c) the last minute of trading for the day.

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ANSWER KEY

Question 10: In order to settle futures contracts, a settle price is determined each day. This price is calculated as the average of all trades for a futures contract during: c) the last minute of trading for the day.

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Unit 4

UNIT 4: INTEREST-RATE FUTURES

INTRODUCTION So far in this course, we have discussed general characteristics of the futures markets and futures contracts. In Units 4 and 5, we focus specifically on interest-rate futures and currency futures. In this unit, you will learn the difference between cash-settled and deliverable interest-rate futures contracts. You will also be introduced to the application of interest-rate futures to hedge interest-rate risk.

UNIT OBJECTIVES When you complete this unit, you will be able to: n

Identify the major types of interest-rate futures

n

Recognize how interest-rate futures can be used to hedge interest-rate risk

n

Recognize the benefits and limitations of interest-rate futures

MAJOR TYPES OF INTEREST-RATE FUTURES CONTRACTS Similar to FRA or bond forward

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An interest-rate future contract is similar to an FRA contract or bond forward contract (repurchase agreement) except that it is standardized, adds mark-to-market margining to reduce credit risk, and is established through an organized exchange. There are two major forms of interest-rate futures contracts: n

Cash-settled contract

n

Deliverable contract

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INTEREST-RATE FUTURES

Futures used to hedge short-term interest-rate risk often are "cash settled." Cash-settled futures contracts do not provide for the delivery of a security; they simply have a final variation margin cash payment based upon an exchange-determined settlement price. Futures on longer-term interest rates often allow for actual delivery of interestearning securities, and settlement through delivery of the security is relatively common. The two major forms of interest-rate futures contracts can be easily represented by the EURODOLLAR (ED) futures contract and the US BOND (US or BD) futures contract. Cash-settled Futures Contracts Marked to market

Cash-settled interest-rate futures contracts specify the method for determining a final settlement price. Prior to final settlement, all interest-rate futures contracts are marked-to-market to identify the change in market price. The “losing” party must pay the revaluation loss to the exchange, which pays the identical amount to the “gaining” party.

Eurodollar futures

The ED futures contract is a cash-settled contract. Separate ED contracts for each quarter starting currently and covering a ten-year period are offered on exchanges such as the Chicago Mercantile Exchange ( CME). The contracts mature in March, June, September, and December. The final settlement date is the second London business day before the third Wednesday of the month. On this final settlement date, the CME asks a number of approved banks in the London inter-bank market for interest rates on USD 3-month (quarterly) deposits and loans. The resulting interest rate (in percent) is subtracted from 100 to determine the final settlement price for that ED contract. For any date prior to the final settlement date, the exchange uses as a settlement price the trading market’s closing price for the ED futures contract. The contract defines a minimum price movement (called one "tick") of 0.01% (one basis point). For example, a 7.5% interest-rate creates a price of 92.50. A rise in interest rates to 7.51% creates a fall in price to 92.49.

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4-3

The contract also defines that for each tick change in price, the margin payment is USD 25 per contract. For example, the buyer of one ED contract at a price of 92.50 would pay USD 25 to the futures exchange if the price changed to 92.49. The futures exchange would pay USD 25 to the seller. Deliverable Contract Provide for delivery of a security

For those interest-rate futures contracts which provide for delivery of a security, the contract defines which securities are acceptable to be delivered to close or settle a futures position. Generally, the futures seller notifies the exchange of an impending delivery. The exchange then randomly chooses a futures buyer and informs the buyer which security the buyer will receive and the amount of cash the buyer needs to supply to the exchange. The seller delivers the security to the exchange, which then delivers the security to the buyer.

U.S. bond futures

The US BOND future is a deliverable contract. Each bond future has a deliverable month which coincides with its maturity. Contract deliverable months are the same as the ED maturities: MAR, JUN, SEP , DEC. For example, the DEC 99 bond future matures in December of 1999. The seller of the DEC 99 US BOND future notifies the exchange (Chicago Board of Trade, CBT ) of the day within the deliverable month when the seller will deliver a bond. The seller also informs the exchange of the particular US Treasury bond which will be delivered (USD 100,000 face value). Deliverable bonds must have a maturity of at least 20 years and must have at least 15 years until the first call date. Independent of the bond chosen, a face value of USD 100,000 must be delivered to settle the contract. To determine the invoice amount, the exchange adjusts the settlement price of the futures contract (using a conversion factor) to account for the specifics of the bond to be delivered. The exchange also adds the accrued interest for the bond to be delivered.

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INTEREST-RATE FUTURES

The exchange then randomly chooses a futures buyer and tells the buyer which security the buyer will receive and the amount of cash the buyer needs to supply to the exchange. The seller delivers the security to the exchange, which then delivers the security to the buyer. Simultaneously, the buyer delivers the invoice amount to the exchange which delivers the invoice amount to the seller.

USING INTEREST-RATE FUTURES TO HEDGE INTEREST-RATE RISK Which contracts and how many?

To hedge interest-rate risk with interest-rate futures, it is necessary to decide which contracts to use and how many to buy or sell. The most straightforward approach to determining an interest-rate futures hedge is to follow these steps: 1) Determine which interest-rate index ( LIBOR, prime, etc.) and maturity creates the risk in a position. * 2) Determine the amount of profit / loss on the position that will occur from a one basis point increase in interest rates. ** 3) Determine which futures contract is priced the closest to that interest-rate index and maturity (exact matches rarely exist). * 4) Determine the amount of profit / loss on one futures contract that will occur from a one basis point increase in interest rates. ** 5) Divide the result in (2) by the result in (4). * To be accurate, one interest-rate risk position may be divided into separate, equivalent positions. For example, a three-year agreement can be separated into 12 sequential quarterly agreements. The specific index also affects the value of the position. ** To be accurate, the profit / loss sensitivity calculation should include present value (time-value-of-money) concepts, which means that all calculations should be discounted to spot dates. Let’s apply each of these steps to an example of how a cash-delivered Eurodollar futures contract may be used to hedge interest-rate risk.

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INTEREST-RATE FUTURES

Example

4-5

Consider a multi-national borrower that pays, on a quarterly basis, three-month USD LIBOR + 0.50% on funding of USD 100 MM. Step 1:

Three-month LIBOR

If three-month LIBOR increases by 0.01%, the additional cost to the borrower is approximately 1/4 x 0.0001 x USD 100 MM = USD 2,500. Step 2:

One basis point increase = $2,500

The higher the value of LIBOR at the maturity of the ED futures contract, the lower the ED contract price, since the exchange will subtract the market LIBOR from 100 to determine the final settlement price for the ED contract. Therefore, the borrower will want to sell the ED contract at its current price, and receive variation margin payments from the exchange as LIBOR rises and the ED contract price falls. Step 3:

Borrower decides to sell ED contracts

Each ED contract pays USD 25 per basis point change in price. Step 4:

Amount of profit/loss in one contract = $25

The borrower will sell approximately 100 three-month ED contracts. Step 5:

USD 2,500 / USD 25 = 100 contracts

Now let’s apply this to a specific contract to see how the borrower is hedged if LIBOR increases. Suppose the ED futures contract price is initially 95.46. This implies an interest rate of 100.00% - 95.46% = 4.54%. If that interest rate can be fixed with the ED contract, the total interest expense will be 4.54% + 0.50% spread = 5.04%. This cost equals approximately USD 100,000,000 x 0.0504 x 1/4 = USD 1,260,000.

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INTEREST-RATE FUTURES

In Figure 4.1, you can see that, if the cash market three-month LIBOR on the borrower's rate-setting date is the same as that implied by the ED futures contract price, then the borrower is hedged (ignoring timevalue-of-money). The total cost of borrowing is 5.04% or USD 1.26 million. QUOTES: Market LIBOR:

4.00%

5.00%

6.00%

Loan interest rate:

4.50%

5.50%

6.50%

ED future price:

96.00

95.00

94.00

Loan payment:

-4.50%

-5.50%

-6.50%

Futures payment:

-0.54%

+0.46%

+1.46%

Total cost:

-5.04%

-5.04%

-5.04%

Loan payment:

-1.125

-1.375

-1.625

Futures payment:

-0.135

+0.115

+0.365

Total cost:

-1.260

-1.260

-1.260

COST IN PERCENT:

COST IN CURRENCY (US$ MILLIONS):

Figure 4.1: Borrower’s hedge with ED contract

Additional Considerations When Hedging with Futures You should recognize that the preceding example is simplified. To illustrate the hedging concept, it ignores some practical difficulties. Actual number of days

In the example, we assumed that a quarter equals exactly 90 days. Actual loan interest payments are based upon the exact number of days divided by 360, which is rarely 1/4 (90 / 360). When the actual number of days in the period is not 90, the amount of future contracts needed to hedge must be modified.

Timing of payments

A second issue is the timing of payments. The loan interest is paid at the end of the payment period, but the futures payments are exchanged daily until the rate setting date. The number of futures contracts used to hedge should be reduced to adjust for the time value of money.

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Different maturities

4-7

A more difficult problem is the reality that the ED contract maturity is rarely the same as the borrower's rate-setting date. As such, the ED hedge must be closed (offset) prior to the expiration of the futures contract. The profit from hedge will be based on the ED futures price and the cost of the loan will be based on cash market LIBOR. Unfortunately, there is no reason to believe that the cash market LIBOR will be identical to 100 - ED price on that date. The risk that these will not change the same way is often referred to as "basis" risk. In this case, the risk is more specifically called a “yield-curve risk,” since the ED contract is essentially an unmatured 3-month FRA with a maturity less than 3 months, while the cash market LIBOR is a spot, three-month rate. Notice that most futures hedges will be offset prior to the futures maturity. Stated another way, when picking a futures contract to hedge a risk, the futures contract will normally have a maturity past (greater than) that of the underlying position.

Other indices

A final consideration is the fact that many interest-rate risks are based upon indices other than 3-month LIBOR. In the case of 6-month LIBOR, or related indices, a combination of ED contracts may suffice. For other indices, some residual basis risk may be unavoidable. Adjustments to the futures hedging strategy are possible in all of these cases, but such strategy exceeds the scope of this workbook.

Modify hedging approach

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The conclusion from this ED hedging example is that ED futures can be very valuable tools for hedging interest-rate risk, but that various practical difficulties preclude the use of futures for most bank customers. To properly hedge with futures of any type, the hedger must modify the hedging approach for: n

Differences between the risk index of the portfolio and that of the future

n

Differences in risk-setting dates between the underlying position and future

n

Differences in cash flow dates for futures profit / loss versus portfolio

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INTEREST-RATE FUTURES

These hedging modifications occur every day, and futures payments occur every day as well. As such, the administrative burden of futures contracts is a significant disadvantage when compared to forward contracts such as FRAs. Who Should Use Futures for Hedging? Large international banks use futures

Financial futures contracts (such as the ED contract) are used primarily by the large international banks in the world. These parties are willing to accept the administrative hassles and slight basis risk involved in the contracts in order to have very liquid hedging markets which have no credit risk. Let’s look at the advantages and disadvantages of ED futures for large international banks. Advantages n

ED futures have virtually no credit risk, but FRAs have credit risk and usage of FRAs requires credit lines.

n

ED futures have significant liquidity and very small bid / offer

spreads. Disadvantages n

ED futures are standardized, and generally do not exactly offset

the risk of particular dates, amounts, and sizes of customer transactions. n

Bank customers use FRAs

In order to have no credit risk, ED futures require constant margin transfers.

Bank customers are more properly advised to use custom-made financial forward contracts which can meet the particular index, date, and amount of risk which the customer needs to hedge. These are the advantages and disadvantages of forward rate agreements (FRAS) for the bank’s customers.

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4-9

Advantages n

FRAs can be written for any rate index, any payment frequency,

any payments dates, and any amount. n

FRAs are easy to administer because they do not require daily

management. Payment is after the rate settlement date. Disadvantages n

The bid / offer spreads of FRAs are higher than those of ED futures.

n

The usage of FRAs decreases the available credit lines which the customer has with the bank offering the FRA.

Financial futures markets are wholesale rate-risk-management markets, whereas forward markets are closer to retail rate-riskmanagement markets. Bank customers should generally "shop" in the retail (forward) market. Large banks, the purveyors of rate risk products, should generally "shop" in the wholesale (futures) market. Interest-rate futures are now traded around the world. Many of the popular contracts are similar to the ED and US BOND futures we have discussed. In addition, short-term (bill or other paper) future contracts exist which effectively hedge short-term interest-rate risk. Interest-rate futures also exist for the British Pound, Japanese Yen, Canadian Dollar, and Australian Dollar.

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INTEREST-RATE FUTURES

SUMMARY Interest-rate future contracts are similar to FRAs or bond/bill forward contracts (repurchase agreements), except that they are standardized, add mark-to-market margining to reduce credit risk, and are established through an organized exchange. Futures used to hedge short-term interest-rate risk often are "cash settled." Cash-settled futures contracts do not allow for the delivery of a security; they simply have a final variation margin payment based upon an exchangedetermined settlement price. Futures on longer-term interest rates often allow for actual delivery of interest earning securities; settlement through delivery of the security is relatively common. The most popular interest-rate future is the EURODOLLAR (ED) future which is priced against 3-month USD LIBOR quotes. ED contracts are very liquid, with huge daily volume and a large open interest. Though ED futures can be used by individual companies to hedge loan interest risk, they are primarily used by large multi-national banks to hedge USD interest-rate risk. Due to the standardization and margining process involved in the ED future contract, the administrative hassles generally outweigh the benefits for small companies needing to hedge interest-rate risk. These small companies generally turn to banks, which provide custom interest-rate risk products such as FRAs. Forward products have the benefit of matching actual customer dates, rates, and amounts of risk. The banks which offer the forward and swap contracts to customers often use ED futures contracts to hedge the resulting risk to the bank. The ED hedge requires constant modification to account for changing time-value-of-money issues. In addition, a basis risk is often accepted by the banks using ED contracts as a hedge. The benefit to the bank is that the ED contract is extremely liquid with small transaction costs and no credit risk. Since the price of an ED contract is inversely related to changes in interest rates, when a bank hedges a risk of rising interest rates, it sells ED contracts. When the risk is that of falling interest rates, the bank buys ED contracts. The profit or loss from the futures contracts is received / paid daily, although the gains / losses on the underlying position are often not realized until some future date.

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4-11

You have completed Unit 4: Interest-rate Futures . Please complete the Progress Check to test your understanding of the concepts and check your answers with the Answer Key. If you answer any questions incorrectly, please reread the corresponding text to clarify your understanding. Then, continue to Unit 5: Currency Futures.

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þ PROGRESS CHECK 4 Directions: Determine the correct answer to each question. Check your answers with the Answer Key on the next page.

Question 1: Futures on longer term interest rates usually are settled: ____ a) in cash with a variation margin payment. ____ b) with the delivery of an interest bearing security. ____ c) directly between the buyer and the seller. ____ d) based on the London inter-bank market for interest rates. Question 2: Which three of the following are characteristics of an interest-rate future? ____ a) Mark-to-market margin process ____ b) can be written for any date ____ c) Are standardized ____ d) Have similar credit risk to that of an FRA ____ e) Are traded through an organized exchange ____ f) Are available for every interest-rate

Question 3: If Bigbank expected to receive USD 3-month LIBOR on August 24, 2000, which of the contracts on page 3-2 would it use to hedge the interest-rate risk? ________________________________________

Question 4: Continuing from Question 3, at what price did the contract settle? ________________________________________

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ANSWER KEY

Question 1: Futures on longer term interest rates usually are settled: b) with the delivery of an interest bearing security.

Question 2: Which three of the following are characteristics of an interest-rate future? a) Mark-to-market margin process c) Are standardized e) Are traded through an organized exchange

Question 3: If Bigbank expected to receive USD 3-month LIBOR on August 24, 2000, which of the contracts on page 3-2 would it use to hedge the interest-rate risk? Sep 2000 ED Future

Question 4: Continuing from Question 3, at what price did the contract settle? 93.56

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PROGRESS CHECK 4 (Continued)

Question 5: If Bigbank hedged as in Questions 3 and 4, what interest rate would it expect to have fixed? ________________________________________

Question 6: Benefits of ED futures or FRA are listed below. Obviously, any party would like these benefits, but certain benefits are more important to banks, and certain of them are more important to bank customers. Place a "C" next to any which is a primary concern (benefit) for a small company, and a "B" next to those which are a primary concern (benefit) for a large bank. ____ ED futures have no credit risk. ____ FRAs have no margin payments. ____ FRAs can be written for any date, amount, or rate. ____ ED futures have huge liquidity. ____ ED futures have small bid / offer spreads. ____ FRAs are simple contracts which are easy to understand.

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ANSWER KEY

Question 5: If Bigbank hedged as in Questions 3 and 4, what interest rate would they expect to have fixed? 100.00% - 93.56 = 6.44%

Question 6: Benefits of ED futures or FRA are listed below. Obviously, any party would like these benefits, but certain benefits are more important to banks, and certain of them are more important to bank customers. Place a "C" next to any which is a primary concern (benefit) for a small company, and a "B" next to those which are a primary concern (benefit) for a large bank. B

ED futures have no credit risk.

C

FRAs have no margin payments.

C

FRAs can be written for any date, amount, or rate.

B

ED futures have huge liquidity.

B

ED futures have small bid / offer spreads.

C

FRAs are simple contracts which are easy to understand.

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Unit 5

UNIT 5: CURRENCY FUTURES INTRODUCTION In the Foreign Exchange workbook, there is a discussion of foreign exchange forwards and their use in guaranteeing the exchange rate between two currencies on a future date. Like interest-rate forwards, these contracts carry credit risk. As you have seen in Unit 2, futures contracts are often used to reduce credit risk. In this unit, you will learn about those specialized futures contracts called “currency futures.” You will learn what is included in currency futures contracts and how they reduce currency risk.

UNIT OBJECTIVES When you complete this unit, you will be able to: n

Recognize how a currency futures contract differs from a foreign exchange forward contract

n

Recognize how currency futures hedging differs from foreign exchange forward hedging

CURRENCY FUTURES CONTRACTS Reduce credit risk

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In the first part of this workbook, we discussed how interest-rate forward contracts are used to guarantee an interest rate at some future date. The same can be said of foreign exchange forwards (also referred to as FX or currency forwards), which guarantee an exchange rate between two currencies. Both interest rate forward contracts and foreign exchange forward contracts have credit risk. You have seen how futures are used to reduce the credit risk associated with interest-rate forwards. Likewise, currency futures contracts are used to reduce the credit risk associated with FX forwards.

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CURRENCY FUTURES

Contract Features Currency future vs. FX forward

A currency futures contract is similar to an FX forward contract, except that it: n

Is standardized

n

Adds mark-to-market margining to reduce credit risk

n

Is established through an organized exchange

Unlike many interest-rate futures, a currency futures contract provides for actual delivery of currency — and settlement through delivery of the currency is common. Each contract defines: 1. The amount of currency to be delivered to satisfy the contract 2. A minimum price movement called a tick 3. A last trade date 4. A final settlement date Standard contract size

Contracts specify a fixed amount of a currency which is either bought or sold for another currency. Many of the popular currency futures contracts price the contract in US dollars per unit of contract currency. This is opposite from most international foreign exchange dealers' quoting conventions.

Example

A popular futures contract is the Euro (EUR) future traded on the Chicago Mercantile Exchange (Refer to the Futures Prices on page 3-2). This future is abbreviated by the exchange as EUR. The contract specifies the following: 1. An amount of EUR 125,000 per contract with a price expressed in USD per EUR 2. The minimum price increment is USD 0.0001 per EUR which equals USD 12.50 per contract.

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5-3

The DM contract in the example has the following terms: Contract currency:

Euro

Pricing currency:

US Dollar

Contract amount:

EUR 125,000

Minimum price change:

USD 0.0001 (one tick)

Tick value:

USD 12.50 per contract

Similar contracts priced in USD exist for the British Pound (62,500), Japanese Yen (12.5 million), Swiss Franc (125,000), Canadian Dollar (100,000), Australian Dollar (100,000), and Mexican Peso (500,00). Other contracts exist which do not price in USD, but follow the rest of the conventions described above. Delivery dates

The delivery dates of currency futures contracts are normally set three months apart, corresponding closely with the other financial futures contracts. Just like interest-rate futures, the maturity dates of currency futures usually are in the months of March, June, September, and December. These maturities are abbreviated MAR, JUN, SEP, DEC. Anyone holding a net short position in EUR futures on the delivery date is required to deliver EUR 125,000 per contract to the clearinghouse. Those participants who have not offset positions prior to the end of the last trade date must deliver currency to the clearinghouse to settle their positions. In exchange, the seller receives the final settlement price (market price on the last trade date) in the dollar equivalent of the number of EUR futures contracts times EUR 125,000. Through the daily margining process, any change in contract price after the original trade date is paid or received prior to final settlement.

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CURRENCY FUTURES

HEDGING WITH CURRENCY FUTURES Hedge against fluctuating exchange rates

If a company expects to receive EUR 1,000,000 on April 15, 200X, but wishes to have USD instead, it may sell EUR futures to hedge the risk of fluctuating exchange rates. Since each currency contract is for EUR 125,000, the company will need to sell eight* futures contracts: 1,000,000 _________

= 8 futures contracts

125,000

*Note: When dealing in large volumes in the futures market, financial institutions make adjustments to the number of contracts to account for interest paid and received on variation margins, but this is not relevant for most small hedgers.

The company sells JUN 200X EUR futures contracts and closes before the maturity date. The company chooses the June contract because it must select a maturity date that is closest to the date it receives the funds (April 15) and that occurs after it has received the money. As market rates change prior to April 15, the company either pays or receives variation margin in its margin account. On April 13, the spot market sets the exchange rate for delivery on April 15; the company does the following: 1. It agrees to sell in the spot market the EUR 1,000,000 it will receive in two days. 2. At the same time, the company buys 8 EUR JUN futures contracts at the current futures market price. This will close its futures position; any profit or loss on the futures hedge will have been settled through the daily margining.

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5-5

If the company sells the 8 EUR futures contracts at a price of EUR 1 / $0.5126, and later purchases 8 EUR futures contracts at EUR 1 / $0.5050, the profit per EUR will be $0.0076. This profit multiplied by 125,000 ( EUR per contract) equals $950 per contract. Since there are eight contracts, the total profit is $7,600. "Fair" contract price

Due to competitive trading and hedging with these currency futures contracts, the contract price prior to final settlement is usually "fair," which means that it incorporates current market FX forward rates (which are supposed to incorporate interest rates and spot exchange rates). For example, if the FX forward market price for one of the futures settlement dates is USD 1 / JPY 115.000, then the JPY futures price is likely to be USD 1 / JPY 115.000, or JPY 1 / USD 0.008696. Financial newspapers will list this price simply as 0.8696 or 8696.

Forwards hedge vs. futures hedge

This does not mean the currency futures hedge will yield the same exchange rate as an FX forward hedge. With forwards, a hedger can pick the actual transaction date of the underlying position. With futures, the hedger must choose the next futures delivery date. Thus, the futures hedge will yield a result nearly identical to hedging with an FX forward with a maturity equal to that of the futures date. Of course, offsetting an FX forward prior to maturity has the same price risk as illustrated above for the currency futures.

SUMMARY Currency futures contracts are similar to FX forward contracts — except they add mark-to-market margining to reduce credit risk, are standardized, and are established through an organized exchange. Currency futures exist for all major trading currencies. Most often, currency futures are quoted in US dollars.

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CURRENCY FUTURES

If a company wishes to hedge a currency transaction which will occur some time in the future, it can purchase or sell a currency future with a maturity no less than the expected transaction date. On the expected transaction date, the company can offset its currency futures position. Daily margining prior to offsetting will provide hedge profit or loss. Due to the limited number of futures dates, currency futures hedges are often offset prior to maturity. Due to the dependence on the futures market price at the time of offset, futures contracts have risks which can be avoided with FX forward contracts. The great advantage of currency futures is the lack of credit risk due to the daily margining.

Congratulations! You have completed the final unit in the Futures workbook. Please check your understanding of Unit 5, Currency Futures, by completing the Progress Check which follows.

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CURRENCY FUTURES

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5-9

þ PROGRESS CHECK 5 Directions: Please answer the questions below. Compare your answers with the Answer Key on the following page. Question 1: Which of the following are characteristics of currency futures? _____ a) Mark-to-market margin process _____ b) Can be written for any date _____ c) Are standardized _____ d) Have similar credit risk to that of an FRA _____ e) Are traded through an organized exchange _____ f) Are available for every currency Question 2: Currency futures hedging may not yield the same total exchange rate as FX forwards hedging because: _____ a) currency futures contracts are standardized. _____ b) currency futures specify a fixed amount of a particular currency. _____ c) the currency futures transaction date must fall on the next futures date. _____ d) the contract price prior to settlement is fair. Question 3: If Bigbank expected the receipt of JPY 500 million on November 3, 1999, which of the contracts (on page 5-8) would it use to hedge the currency risk? Question 4: Continuing from Question 3, at what price will the contract settle? Question 5: If Bigbank hedged, as in Questions 3 and 4, what amount of USD would they expect to receive from the hedge? (Disregard time value of money and interest rates.)

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ANSWER KEY

Question 1: Which of the following are characteristics of currency futures? a) Mark-to-market margin process c) Are standardized e) Are traded through an organized exchange

Question 2: Currency futures hedging may not yield the same total exchange rate as FX forwards hedging because: c) the currency futures transaction date must fall on the next futures date.

Question 3: If Bigbank expected the receipt of JPY 500 million on November 3, 1999, which of the contracts (on page 5-8) would it use to hedge the currency risk? December 1999 JPY Future

Question 4: Continuing from Question 3, at what price will the contract settle? .9273 = USD 0.009273 per JPY

Question 5: If Bigbank hedged, as in Questions 3 and 4, what amount of USD would they expect to receive from the hedge? (Disregard time value of money and interest rates.) USD 0.009273 per JPY x JPY 500 million = USD 4,636,500 v-1.2

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Appendices

APPENDIX A THE MECHANICS OF FUTURES MARKETS ELEMENTS OF THE FUTURES MARKET Since future contracts are established through an organized exchange, we are including some information on the technicalities of the futures market. This material is for reference only — you are not expected to learn it for the exam. Government regulations

In every country, there is a governmental body that sets the regulations for the futures market and issues accreditation charters to futures brokers.

Futures exchange

A futures exchange is a financial marketplace for trading futures contracts. In addition to being the physical place where futures are traded, futures exchanges enforce government regulations, disseminate pertinent information, and provide avenues for handling exceptions.

Maximum accepted limits

Futures exchanges set their own daily maxima for each type of contract: if prices fluctuate below or above the maximum accepted limits, trading is halted for the day.

Categories of rules

Every futures exchange imposes certain rules and regulations. These rules fall into six areas: 1)

Contract specifications – Contract size – Quality of asset – Delivery rules

2)

Firm financial requirements – Net worth – Liquidity – Leverage – Customer margin requirements

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A-2

APPENDIX A

– Maximum daily price fluctuations – Limits per individual trader 4)

Dispute settlement

5)

Surveillance – monitoring of manipulative practices

6)

Emergency powers – Alteration of contract terms – Trading suspension

Membership

Futures exchanges are limited-membership organizations where each member owns a seat. Seats only become available when a member seat is sold. Brokers who do not own seats can only trade through a member broker. An individual or corporation that wishes to trade in the futures market opens an account with one of the accredited brokers. Both parties must clearly understand the objectives for trading and the mutual signing of forms that defines each side's responsibilities. A corporation is required to empower, by vote of the board, those individuals entitled to issue trading orders in its name.

CLEARINGHOUSE System within the exchange

A clearinghouse is a system within an exchange that facilitates delivery and receipt of futures contracts. All futures exchanges contain a clearinghouse to: n

Match buyers and sellers

n

Transfer funds from buyers to sellers

n

Transfer assets from sellers to buyers

n

Guarantee proper completion of all contracts

n

Provide a mechanism for delivery of mature contracts

In order to accomplish the above, clearinghouses can:

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APPENDIX A

Clearinghouse role

Daily futures positions

A-3

n

Collect margin, both initial and variation

n

Enforce daily settlements on changes in contract value

n

Assess the capital resources of members

Once a trade has been concluded, both sides turn it over to the clearinghouse which then assumes the role of the "other side" to each party. The clearinghouse becomes the buyer to every seller, and the seller to every buyer. This arrangement has some advantages: n

A trader holding a contract can offer the contract without consent of the original counterparty.

n

Brokers settle one net transaction per day with the clearinghouse, rather than settling each transaction as it occurs.

n

Clearinghouses guarantee each transaction so traders do not have to evaluate the credit of each counterparty.

Every futures position is marked-to-market daily. This means that the value of a futures trading account changes according to current market value. All profits are credited to the trader's account and can be either withdrawn or used for other transactions. Losses are debited to the trader's account and forwarded to the clearinghouse. If there is not enough money in the account to cover the losses, a variation margin call is made and the investor must deposit the money immediately. Now that we've seen how futures exchanges and clearinghouses are structured, let's move to the various types of orders that a customer might issue to a broker of futures contracts.

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APPENDIX A

FUTURES MARKET ORDER Order specifications

A futures market order is a buy or sell order from customer to broker. It must include the following specifications: n

Exchange on which the contract is to be traded

n

Buy or sell transaction

n

Number of contracts

n

Delivery month

n

Type of underlying asset

n

Price

n

Type of order

n

Length of time the order is to remain in effect

Types of Futures Market Orders There are various types of orders that can be specified by the party placing the transaction. Market order

The most common type of order is a market order. This is an order to buy or sell a futures contract at the best available price in the market. Example:

Market order to buy Exchange: Buy/Sell: Quantity: Delivery Month: Type: Price: Type: Duration:

LIFFE Buy 2 June Sterling time deposit Market Market N/A

If current sterling time deposit contracts are trading at bid 90.05 and ask 90.10, the floor broker will try to buy at 90.10 or below. However, the broker might only be able to buy one contract at 90.10 and the other at 90.12.

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APPENDIX A

Limit order

A-5

A customer who wants to buy or sell at a specified price will issue a limit order, which instructs the broker to buy or sell only at a particular price or better. A limit order to buy is placed below the current market price, with the transaction to take place at or below the limit. A limit order to sell is placed above current market price, with the transaction to take place at or above the limit. Example: Limit order to sell Exchange: Buy/Sell: Quantity: Delivery Month: Type: Price: Type: Duration:

CBT Sell 4 December T-bond 88 12/32 Limit N/A

Day-limit order

The floor broker is instructed to sell December T-bond futures at or above 88 12/32nds. The current price is 87 18/32nds. If the price rises to 88 12/32nds, the broker will sell the four T-bond contracts at or above that price. If no duration is specified, the order is presumed to be a day-limit order – the order is automatically canceled if the price limit is not reached within one day.

Market-iftouched (MIT)

A type of order that combines a market order and a limit order is the market-if-touched (MIT) . This type of order becomes a market order when a preset market price is reached. Example: MIT order to buy Exchange: Buy/Sell: Quantity: Delivery Month: Type: Price: Type: Duration:

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IMM Buy 4 September 90-day T-bill 85.00 MIT N/A

A-6

APPENDIX A

The market is trading at 86.00 and the customer places an MIT order to buy four September T-bill contracts at 85.00. When the market price drops to 85.00, the broker immediately enters the market to get the best price for the customer. It turns out that 85.00 is the low for the day, and the broker buys the contracts at a price of 85.05. The broker places the order at the best market price after the market has reached the price specified in the MIT contract. Stop order

The stop order is similar to a market-if-touched order. However, the specified price for a buy order is above market and the specified price for a sell order is below market. Stop buy orders are generally used to limit loss or to protect unrealized profits on a short sale. Stop sell orders are generally used to protect unrealized profits or to limit loss on a holding. Example: Stop order to sell Exchange: Buy/Sell: Quantity: Delivery Month: Type: Price: Type: Duration:

LIFFE Sell 3 December Eurodollar time deposit 90.20 Stop Month

A customer has a long position in three December Eurodollar futures and wishes to cut her losses if the market moves against her. The current price is 91.00. The customer enters a stop sell order for three contracts at 90.20. When the market trades at 90.20, the broker enters the market and sells three contracts at 90.19. The duration of this contract is one month – it will continue to be an active order until the last trading day of the month when it will be canceled automatically.

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APPENDIX A

MIT order vs. stop order

A-7

Let's look closely at the difference between a market-iftouched order and a stop order. The significant difference between them is the location of the specified price relative to current market prices. A buying customer will specify a price above current market in a stop order and below current market in an MIT order. A selling customer will specify a price above current market in an MIT order and below current market in a stop order.

Figure A.1: Market-If-Touched (MIT) Order vs. Stop Order

Stop-limit order

A stop order can also be entered with a limit. A stop-limit order means that a stop order becomes a limit order instead of a market order when the stated price is reached. Example: Stop-limit order to buy Exchange: Buy/Sell: Quantity: Delivery Month: Type: Price: Type: Duration:

LIFFE Buy 3 December Eurodollar time deposit 92.20 Stop limit 92.40 GTC

When a price of 92.20 is reached in the market, the order is converted into a limit order to purchase the three contracts at or below 92.40. If the price rises above the 92.40 limit before the order can be filled, the broker waits until the price falls below 92.40.

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APPENDIX A

Good 'til canceled (GTC)

For this order, the duration is good 'til canceled (GTC), which means that the order will remain in effect until the customer instructs the broker to cancel it.

Fill or kill (FOK)

Another specified duration order is fill or kill (FOK) . The specified price in this order can be offered or bid on the trading floor only three times. If it is not executed, it is immediately canceled; or, if the broker can execute part of the order, that is done and the rest is canceled. Example: FOK order to buy Exchange: Buy/Sell: Quantity: Delivery Month: Type: Price: Type: Duration:

LIFFE Buy 4 December Sterling time deposit 89.50 Limit FOK

The customer instructs the broker to buy four contracts for December sterling time deposits at a price of 89.50 on a fillor-kill basis. After three tries, the broker succeeds in buying only two contracts at that price and cancels the other half of the order.

Those are the various types of orders that a customer might issue. Now we'll turn our attention to a couple basic trading strategies.

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APPENDIX A

A-9

Selecting a Strategy Let's look at the example of the Swiss Company's Puerto Rican subsidiary from Question 8, Unit 2. Example

You are the Chief Financial Officer of a company in Puerto Rico, the subsidiary of a major Swiss industrial company. Your subsidiary generates US dollars, and your parent company deals in Swiss francs. It is September and your budget reflects that you are committed to remitting a dividend to your parent in December. The market is quoting the following prices: Spot:

0.4002 (USD per CHF)

Futures (for December delivery):

0.3995

What action should you take in order to guarantee this dividend payment in December? The success of your strategy (purchase Swiss francs for December delivery in order to remit a dividend to the parent company) depends on getting just the right USD / CHF exchange rate future. You should examine your objectives and select the type of order that will provide the best chance of achieving those objectives. How should you order? If you are comfortable with the broker, you will specify "marketif-touched" on a not held basis. This means that the order to buy Swiss francs will not become active until a certain market price is reached and, from that point on, the pit trader will exercise his best judgment. If you are new to this market (and/or not familiar with the broker), you will specify a "stop-limit order," which means that the broker will purchase Swiss francs at the stop price or above, but no further above than the limit price.

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APPENDIX A

FUTURES TRANSACTION Let's look at an example of how a futures transaction might take place. Example

Imagine that you are the Chief Financial Officer of a conservative industrial company in Argentina. You have just discovered the Buenos Aires Futures Exchange and intend to use futures transactions for enhancing your financial activities. In first examining the market and establishing a relationship with a broker, follow this process:

Explore your options

1.

Review legal issues

2.

Examine the kinds of futures available and the depth of trading. You should ask yourself these questions: •

Do the available futures behave closely with, or closely against, the risks I want to hedge? Look for mimicking behavior (underlying assets that follow the trends with which you are concerned, either quite closely or almost completely in the opposite). Remember, the only perfect mimic occurs when the asset traded is the same as the asset you need and, therefore, want to protect against unanticipated variations in its price.

•

How deep is the market? If my company decides to trade in a specific market, will my transaction represent more than 5% of that day's volume? If so, I practically can be assured that my company's action will affect that whole market. This, in turn, may preclude the results that I am looking for.

Call in your legal department and have them review the documentation and the exchange's regulations. Examine these issues: •

How detailed is the documentation?

•

What actions can my company take if the other party defaults?

•

How far will the exchange support my company in its efforts to seek redress?

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APPENDIX A

Select a broker

Open an account

A-11

3.

4.

Seek out a broker with a seat in the exchange to place your orders; it is cheaper, more efficient, and more reliable than going through other intermediaries who must then deal with a broker. Examine the broker's credentials and ask yourself: •

Does s/he trade for other local companies that are reputable?

•

Is s/he sensitive to your intentions?

•

Does s/he offer useful advice?

Open an account and define with the broker the kinds of instruments you will be buying/selling and orders you will be issuing, including any "further instructions" which are appropriate. Also, discuss the mechanics of margins, custody, and delivery terms.

You are now ready to issue your first order.

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APPENDIX A

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APPENDIX B ISO CODES Code

Currency

Code

Currency

ARS AUD ATS BSD BHD BDT BBD BEF BZD BMD BOB BWP BND CAD CLP COP CYP CZK DKK DEM DJF DOP XCD ECS EGP EUR SVC ETB XEU FJD FIM FRF GMD GRD HTG HNL HKD HUF ISK INR IDR IEP ILS ITL JMD JPY

Argentine Peso Australian Dollar Austrian Schilling Bahamian Dollar Bahraini Dinar Bngladesh Taka Barbados Dollar Belgian Franc Belize Dollar Bermudian Dollar Bolivian Boliviano Botswana Pula Brunei Dollar Canadian Dollar Chilean Peso Colombian Peso Cypriot Pound Czech Koruna Danish Krone Deutsche Mark Djibouti Franc Dominican Peso East Caribbean Dollar Ecuadorean Sucre Egyptian Pound European currency El Salvador Colon Ethiopian Birr European Currency Unit Fiji Dollar Finnish Markka French Franc Gambian Dalasi Greek Drachma Haitian Gourde Honduran Lempira Hong Kong Dollar Hungarian Forint Icelandic Krona Indian Rupee Indonesian Rupiah Irish Pound Israel Shekel Italian Lira Jamaican Dollar Japanese Yen

JOD KES KWD MGF MWK MYR MTL MUR MXN MAD NPR ANG NLG NZD NGN NOK OMR PGK PEN PLN PTE QAR SAR SCR SLL SGD ZAR ESP LKR SRG SEK CHF TZS THB TOP TTD TND TRL UGS AED GBP USD VEB ZMK ZWD

Jordanian Dinar Kenyan Schilling Kuwaiti Dinar Malagasy Franc Malawi Kwachi Malaysian Ringgit Maltese Lira Mauritian Rupee Mexican Nuevo Peso Moroccan Dirham Nepalese Rupee Netherlands Antilles Guilder Netherlands Guilder New Zealand Dollar Nigerian Naira Norwegian Krone Omani Riyal Papua New Guinea Kina Peruvian Nuevo Sol Polish Zloty Portuguese Escudo Qatar Riyal Saudi Riyal Seychelles Rupee Sierra Leone Singapore Dollar South African Rand Spanish Peseta Sri Lankan Rupee Surinam Guilder Swedish Krona Swiss Franc Tanzanian Shilling Thai Baht Tonga Pa’anga Trinidad & Tobago Dollar Tunisian Dinar Turkish Lira Ugandan Schilling United Arab Emirates Dirham UK Pound Sterling US Dollar Venezuelan Bolivar Zambian Kwacha Zimbabwe Dollar

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APPENDIX C FINANCIAL DERIVATIVES EXCHANGES’ WEBSITES

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London

LIFFE

www.liffe.com

Paris

MATIF

www.matif.fr

Tokyo

TIFFE

www.tiffe.or.jp

Singapore

SIMEX

www.simex.com.sg

Hong Kong

HKFE

www.hkfe.com

Frankfurt

EUREX

www.eurexchange.com

Chicago

CME

www.cme.com

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GLOSSARY Arbitrage

Simultaneous purchase and sale of the same or closely-related assets in different markets for the purpose of profiting from unequal values

Arbitrager

A trader who plays one market against another, looking for a given product that is overvalued in one market relative to the other

Basis Risk

Risk that the price or rate of one financial contract does not change identically with the price or rate of another financial contract

Buying on Margin

Portion of equity market shares purchase price borrowed from broker

Cash Contract

Agreement to buy or sell an asset for immediate delivery

Clearinghouse

System within an exchange that facilitates delivery and receipt of futures contracts

Contract Delivery Month

Last month of a futures contract during which delivery must take place, unless the contract is offset

Cost of Carry

Cost of holding an asset until delivery date

Currency Futures

A futures contract that is used to hedge currency transactions

Daily Maxima

Maximum upward/downward price fluctuation limits for futures contracts

Day-limit Order

Order that remains active for one day

Fill or Kill (FOK)

Order that broker fills immediately or cancels after three offers or bids; can result in a partially filled order

Floor Brokers

Members of the futures exchange that are affiliated with a member firm and take responsibility for executing the firm's orders

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GLOSSARY

Forward Contract

A binding commitment to either buy or sell an asset in the future at a predetermined price, or to pay/receive in cash the amount of loss/profit caused by a change in an asset's price from the predetermined level

Futures Contract

A standardized agreement to buy or sell (or effect the financial equivalent of buying or selling) a specific quantity and grade of an asset on a specified future date at a pre-defined price (often determined through open outcry) in a regulated marketplace with a margining system, which minimizes credit risk

Futures Exchange

Financial marketplace for the trading of futures contracts

Futures Market

An exchange site that provides a specialized trading floor for the buying and selling of assets for future delivery

Futures Market Order

Buy or sell order given by the client to a broker

Good 'til Canceled (GTC)

Order that remains in effect until customer instructs the broker to cancel

Hedgers

Traders that try to reduce the risks associated with holding, or planning to hold, positions in various markets. These risks may arise from adverse movements in interest rates and/or exchange rates, or from changes in prices of stocks or commodities.

Hedging

Taking a position with a futures contract that offsets a position in another market to minimize risk

Index

An indicator that reflects economic conditions (for example, a stock market index)

ISO

International Standards Organisation. A regulatory body that ratifies internationally accepted protocol for communications in business.

Last Trading Day

Last business day before final settlement of a contract

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GLOSSARY

G-3

Leverage

Ability to control large amounts of resources with small amounts of capital; a high-risk profit opportunity that is disproportionate to the amount invested

Limit Order

Order to buy or sell at a specified price or better

Locals

Traders working on the floor of an exchange who engage in speculation and arbitrage for their own accounts

Long Position

Position held by the buyer of a futures contract

Margin

See "Initial Margin Deposit" and "Variation Margin"

Mark-to-Market

Process of comparing the contract rate to current market conditions

Market-IfTouched Order (MIT)

Combines a market order and limit order; becomes a market order when the specified price is reached or passed. For sell orders, this specified price is above the market price when the order is initiated. For buy orders, this specified price is below the market price when the order is initiated.

Market Order

Order to trade at best available price immediately

Mimicking

Movement of the price of an underlying asset either closely with, or inversely against, a macroeconomic trend

Not Held

Instructions to the pit trader to use his/her best judgment once the order conditions are met

Offset

Transaction that cancels out an equal and opposite transaction

Open Interest

The number of outstanding contracts which have not been offset

Open Outcry

Method used by buyers and sellers on the floor of many futures exchanges to verbally fix contracts

Quotation

Price per contract

Settle Price

Average price of all trades taking place during the last minute of the trading day

Settlement Date Short Position

Date by which an executed order must be completed

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Position held by the seller of a futures contract

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GLOSSARY

Speculation

Engaging in risky transactions which offer the possibility of large returns or losses

Speculators

Traders who try to profit from speculation

Stop-limit Order

Stop order that becomes a limit order when a specified price is reached

Stop Order

Similar to market-if-touched order. It becomes a market order when the specified price is reached or passed. For sell orders, this specified price is below the market price when the order is initiated. For buy orders, this specified price is above the market price when the order is initiated.

Tick

The minimum price movement for a futures contract

Underlying

An asset or intangible on which a futures contract is based

Variation Margin

Amount of funds a trader must add, or can withdraw, as the market price of an asset varies

Yield

Measure of the interest rate implicit in the price of a future

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GLOSSARY

G-5

GLOSARIO Arbitrage/ Arbitraje

Compra y venta simultánea de los mismos activos o activos estrechamente relacionados en diferentes mercados con el fin de aprovechar valores desiguales.

Arbitrager / Arbitrajista

Un operador que hace jugar un mercado contra el otro, buscando un producto determinado que está sobrevaluado en un mercado en relación con el otro.

Basis Risk / Riesgo de Base

Riesgo de que el precio o la tasa de un contrato financiero no cambie en forma idéntica con el precio o la tasa de otro contrato financiero.

Buying on Margin / Compra sobre el Margen

Porción del precio de compra de acciones del mercado tomada del comisionista.

Cash Contract / Contrato al Contado

Acuerdo de comprar o vender un activo para entrega inmediata

Clearinghouse / Cámara de Compensaciones

Sistema dentro de una bolsa que facilita la entrega y recibo de contratos de futuros

Contract Delivery Month / Mes de Entrega del Contrato

Ultimo mes de un contrato de futuros durante el cual debe efectuarse la entrega, a menos que el contrato se compense

Cost of Carry / Costo de Mantenimiento

Costo de mantener un contrato hasta la fecha de entrega

Currency Futures / Futuros de Moneda

Un contrato de futuros que se usa para cubrir transacciones en moneda

Daily Maxima / Máxima Diaria

Límites máximos de fluctuación de precio hacia arriba o hacia abajo para contratos de futuros.

Day-limit Order / Orden de Límite Diario

Orden que permanece activa por un día

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GLOSSARY

Fill or Kill (FOK) / Cumplir o Anular

Orden de que el comisionista de bolsa cumpla inmediatamente o cancele después de tres ofertas de compra o venta; puede resultar en una orden parcialmente cumplida

Floor Brokers / Comisionistas de Bolsa

Miembros de la bolsa de futuros que están afiliados a una firma miembro y asumen la responsabilidad de ejecutar las órdenes de la firma

Forward Contract / Contrato a Término

Un compromiso vinculante de comprar o vender un activo en el futuro a un precio determinado, o de pagar/recibir al contado el monto de pérdida/ganancia causada por un cambio en el precio de un activo desde el nivel predeterminado

Futures Contract / Contrato de Futuros

Un acuerdo estandardizado de comprar o vender (o efectuar el equivalente financiero de comprar o vender) una cantidad y calidad específica de un activo en una fecha futura especificada a un precio predefinido (a menudo determinado a viva voz) en una plaza regulada con un sistema de márgenes, que minimiza el riesgo de crédito

Futures Exchange / Bolsa de Futuros

Plaza financiera para la negociación de contratos de futuros

Futures Market / Mercado de Futuros

Un lugar de intercambio que brinda un recinto de trading especializado para la compra y venta de activos para entrega futura

Futures Market Order / Orden del Mercado de Futuros

Orden de compra o venta dada por el cliente a un comisionista.

Good ‘til Canceled (GTC) / Vigente hasta su Cancelación

Orden que permanece vigente hasta que el cliente instruye al comisionista para que cancele

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GLOSSARY

G-7

Hedgers / Reductores de Riesgo

Operadores que tratan de reducir los riesgos relacionados con mantener, o planear mantener, posiciones en varios mercados. Estos riesgos pueden surgir de movimientos adversos en las tasas de interés y/o tipos de cambio, o de cambios en los precios de las acciones o commodities

Hedging / Tomar Cobertura

Tomar una posición con un contrato de futuros que compensa una posición en otro mercado para minimizar el riesgo

Index / Indice

Un indicador que refleja las condiciones económicas (por ejemplo, un índice del mercado de valores)

Initial Margin Deposit / Depósito de Margen Inicial

Un depósito de buena fe pagado por los compradores y vendedores en el mercado de futuros

ISO / ISO

International Standards Organisation (Organización Internacional de Estandarización). Una organización reguladora que ratifíca los protocoles aceptados para la comunicación en los negocios

Last Trading Day / Ultimo Día de Trading

Ultimo día laboral antes de la liquidación final de un contrato.

Leverage / Apalancamiento

Capacidad de controlar grandes montos de recursos con pequeños montos de capital; una oportunidad de ganancia de alto riesgo que no está en proporción con el monto invertido

Limit Order / Orden Limitada

Orden de comprar o vender a un precio especificado o mejor

Locals / Locales

Traders que trabajan en el piso de una bolsa de valores y especulan y hacen arbitrajes para sus propias cuentas

Long Position / Posición Comprada

Posición mantenida por el comprador de un contrato de futuros

Margin / Margen

Ver “Depósito de Margen Inicial” o “Margen de Variación”

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GLOSSARY

Mark-to-Market / Ajustar a Valor de Mercado

Proceso de comparar la tasa del contrato con las condiciones del mercado actuales

Market-If-TouchedOrder (MIT) / Orden de Operar al Llegar al Precio

Combina una orden de operar y una orden limitada; se convierte en una orden de operar cuando se alcanza o se pasa el precio especificado. Para ordenes de vender, este precio especificado está por encima del precio de mercado cuando se inicia la orden. Para ordenes de comprar, este precio especificado está por debajo del precio de mercado cuando se inicia la orden

Market Order / Orden de Operar

Orden de operar al mejor precio disponible inmediatamente

Mimicking / Imitación

Movimiento del precio de un activo subyacente de acuerdo con una tendencia macroeconómica o en forma inversa contra la misma

Not Held / No Mantener

Instrucciones para el operador de utilizar su mejor criterio una vez que se cumplen las condiciones de la orden

Offset / Compensación

Transacción que cancela una transacción igual y opuesta

Open Interest / Interés Abierto

El número de contratos pendientes que no fueron compensados

Open Outcry / Viva Voz

Método empleado por compradores y vendedores en el recinto de muchas bolsas de futuros para fijar contratos verbalmente

Quotation / Cotización

Precio por contrato

Settle Price / Precio de Liquidación

Precio promedio de todas las operaciones que se producen durante el último minuto del día de trading.

Settlement Date / Fecha de Liquidación

Fecha en la cual debe cumplirse una orden ejecutada

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GLOSSARY

G-9

Short Position / Posición Vendida

Posición mantenida por el vendedor de un contrato de futuros

Speculation / Especulación

Hacer operaciones riesgosas que ofrecen la posibilidad de grandes retornos o pérdidas

Speculators / Especuladores

Operadores que tratan de obtener ganancia de la especulación

Stop-limit Order / Orden de SuspenderLimitada

Orden de suspender que se convierte en una orden limitada cuando se alcanza un precio especificado

Stop Order / Orden de Suspender

Similar a la orden de operar al llegar al precio. Se convierte en una orden de operar cuando se alcanza o pasa el precio especificado. Para órdenes de vender, este precio especificado está por debajo del precio de mercado cuando se inicia la orden. Para órdenes de comprar, este precio especificado está por encima del precio de mercado cuando se inicia la orden

Tick / Valor Mínimo de Variación

El movimiento de precio mínimo para un contrato de futuros

Underlying / Activo Subyacente

Un activo o bien intangible sobre el que se basa un contrato de futuros

Variation Margin / Margen de Variación

Monto de fondos que un operador debe agregar, o puede retirar, a medida que varía el precio de mercado de un activo

Yield / Rendimiento

Medida de la tasa de interés implícita en el precio de un futuro

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GLOSSARY

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Index

INDEX A Arbitrage Arbitrager

2-2, 2-3 2-1—2-3, 2-6

B Basis Risk Buying on Margin

4-7, 4-8, 4-10 3-8

C Cash Contract Clearinghouse Contract Month Cost of Carry Currency Futures

1-4 1-4, 5-3, A-2, A-3 3-1, 3-3, 3-5 3-7, 3-9 5-1—5-6

D Daily Maxima Day-limit Order

A-1 A-5

F Fill or Kill (FOK) Floor Brokers Forward Contract Futures Contract

Futures Market Order

A-8 A-4, A-5 1-1—1-5, 1-7, 1-8, 4-1, 4-8—4-10, 5-1, 5-2, 5-5, 5-6 1-1, 1-3—1-8, 2-2, 2-4, 2-5, 3-1, 3-4, 3-6, 3-8—3-10, 4-1—4-3, 4-7, 4-8, 4-10, 4-11, 5-1—5-6, A-1—A-4 1-4, 3-7, 4-3, A-1—A-3, A-10 1-1, 1-7, 1-8, 2-1—2-5, 3-1, 3-9, 4-1, 4-9, 5-4, 5-6, A-1, A-2 A-4

G Good 'til Canceled (GTC)

A-8

Futures Exchange Futures Market

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INDEX

H Hedgers Hedging

2-1—2-3, 2-6, 4-7, 5-4, 5-5 2-1—2-6, 4-6—4-8, 5-1, 5-4, 5-5, A-10

I Index Initial Margin Deposit ISO

2-5, 4-4, 4-7—4-9 1-4, 1-8, 3-8, 3-10 B-1

L Last Trading Day Leverage Limit Order Locals Long Position

A-6, A-7 2-2, 2-6, A-1 A-5, A-7—A-9 2-1, 2-2, 2-3, 2-6 1-6, A-6, A-7

M Margin Mark-to-Market Market-If-Touched Order Market Order Mimicking

1-2—1-7, 1-8, 2-2, 3-1, 3-8, 3-9, 4-1—4-3, 4-8, 4-10, 5-2—5-6, A-1, A-3, A-11 1-2—1-4, 1-8, 4-1, 4-2, 4-10, 5-2, 5-5, A-3 A-5—A-7, A-9 A-4, A-5, A-7 2-4, A-10

N Not Held

A-9

O Offset Open Interest Open Outcry

1-3, 1-6—1-8, 2-2, 2-4, 2-6, 3-4, 4-7, 4-8, 5-3, 5-5, 5-6 3-4, 3-5, 3-9, 4-10 1-6

Q Quotation

3-4, 3-5

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INDEX

I-3

S Settle Price Settlement Date Short Position Speculation Speculators Stop-limit Order Stop Order

3-1, 3-3, 3-4, 3-9, 5-3 3-4, 4-2, 4-9, 5-2, 5-5 1-7, 5-3 2-1, 2-2, 2-5 2-1—2-3, 2-6 A-7, A-9 A-6, A-7

T Tick

4-2, 4-3, 5-2, 5-3

U Underlying

1-4, 1-6, 1-7, 2-4. 2-5, 3-1, 3-4—3-7, 4-7, 4-8, 4-11, 5-5, A-4, A-10

V Variation Margin

3-8, 3-9, 3-10, 4-2, 4-5, 4-10, 5-4, A-3

Y Yield

3-4, 3-7, 3-9, 5-5

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I-4

INDEX

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