22rb fwd+futures

8/7/2019 22rb Fwd+Futures

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Chapter 22

Hedging With Forwards and Futures

Create a position that will offset the price risk of

another holding

holding a short forward position against the long

position in the commodity is a short hedge

a long hedge supplements a short commodity holding

with a long forward position


2/15


Relationship between spot and forward price

movements

basis is spot price minus the forward price for a

contract maturing at date T:

BtT= St- Ft,T

forward price converges to the spot price as the

contract expires hedging exposure is correlation between future

changes in the spot and forward contract prices and

can be perfectly correlated with customized contracts


3/15


Calculating the Optimal Hedge Ratio

net profit from the position

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4/15

Forward and Futures Contracts:

Basic Valuation Concepts Forward and futures contracts are not

securities but, rather,trade agreements that

enable both buyers and sellers of an

underlying commodity or security to lock in

the eventual price of their transaction


5/15

Valuing Forwards and Futures

Valuing forwards

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Valuing futures

contracts are marked to market daily

* = the possibility that forward and futures pricesfor the same commodity at the same point in time

might be different

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6/15

The Relationship Between Spot and

Forward Prices If you buy a commodity now for cash and store

it until you deliver it, the price you want under a

forward contract would have to cover:

the cost of buying it now

the cost of storing it until the contract matures

the cost of financing the initial purchase

These are the cost of carry necessary to move theasset to the future delivery date

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7/15

The Relationship Between Spot and

Forward Prices Contango - high storage costs and no

dividends

Premium for owning the commodity

convenience yield

results from small supply at date 0relative to what is expected at date T

(after the crop harvest)

Backwardated market - future is lessthan spot


8/15

Financial Forwards and Futures:

Applications and Strategies Originally, forward and futures markets were

organized largely around trading agriculturalcommodities

Recent developments in this area have involvedthe use of financial securities as the assetunderlying the contract

Interest rate forwards and futures were among

the first derivatives to specify a financialsecurity as the underlying asset

forward rate agreements

interest rate swaps


9/15


Applications and Strategies Long-term interest rate futures

Treasury bond and note contract mechanics

CBT $100,000 face value

T-bond >15 year maturity T-note 10 year - bond with 6.5 to 10 year maturity

T-note 5 year - bond with 4.25 - 5.25 years

Delivery any day during month of delivery

Last trading day 7 days prior to the end of the month Quoted in 32nds

Yield quoted is for reference

Treasury bonds pay semiannual interest

Conversion factors for differences in deliverable bonds


10/15


Applications and Strategies A duration based approach to hedging

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11/15


Applications and Strategies

A T-Bond/T-Note (NOB) Futures Spread

expecting a change in the shape of the yield curve

unsure which way rates will change long one point on curve and short another point


12/15

Short-Term Interest Rate Futures

Eurodollar and Treasury bill contract mechanics

Chicago Mercantile Exchange (CME or Merc)

International Monetary Market (IMM)

LIFFE

LIBOR

Altering bond duration with futures contracts

Creating a synthetic fixed-rate funding with aEurodollar strip

Creating a TED spread


13/15

Stock Index Futures

Intended to provide a hedge against movements

in an underlying financial asset

Hedging an individual stock with an index

isolates the unsystematic portion of that

securitys risk

Stock index arbitrage

prominent in program trading


14/15

Currency Forwards and Futures

Currency quotations

Direct (American) quote in U.S. dollars

Indirect (European) quote in non U.S. currency

Reciprocals of each other

Interest rate parity and covered interest arbitrage

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15/15

Currency Forwards and Futures

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