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Lecture 4: Futures and Forwards:
Markets, Basic Applications, and Pricing Principles
Dr. Nattawut Jenwittayaroje, CFAFaculty of Commerce and AccountancyChulalongkorn University
01135531: Risk Management and Financial Instrument
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A forward contract is an agreement between two parties in which one party, the buyer (long), agrees to buy from the other party, the seller (short), something (i.e., underlying asset) at a later date (i.e., maturity date) at a price agreed upon (i.e., delivery or forward prices) today
Exclusively over-the-counter The contract is an over-the-counter (OTC) agreement between 2
companies No physical facilities for trading OTC market consisting of direct communications among major
financial institutions
Forward Contracts
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Futures Contracts Similar in principle to forward contracts, but a futures contract is
traded on an exchange, while a forward contract is traded OTC.
the contracts are standardized and specified by the exchange, makingtrading in a secondary market possible.
Give up flexibility available in forward contacting for the sake ofliquidity.
Forward contracts: the terms of the contract (contract size, maturitydate, and etc.) can be tailored to the needs of the traders.
Virtually no credit risk – Futures exchanges provide a mechanism(known as the clearinghouse) that guarantee that the contract will behonored. For forwards contracts, creditworthiness of the seller isimportant.
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Forward Contracts Versus Futures
Forward contracts
Trade on OTC markets
Not standardized
Specific delivery date
Settled at end of contract
Delivery or final cashsettlement usually takesplace
Futures
Traded on exchanges
Standardized contract
Range of delivery dates
Settled daily (by dailymarking to market)
Usually closed out prior tomaturity
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Derivatives Markets in Thailand Thailand Futures Exchange pcl. (TFEX)
SET 50 Index Futures
Single Stock Futures
• For example, ADVANC, PTT, and PTTEP
Gold Futures, Silver Futures, and Brent Crude Oil Futures
USD Futures
Interest Rate Futures
SET 50 Index options
• Call options
• Put options
Agricultural Futures Exchange of Thailand (AFET)
Futures contracts on Natural Rubber Ribbed Smoked Sheets No 3
Futures contracts on White Rice 5% Both Options
Futures contracts on Tapioca Chip 66
SET50 Index Futures Contract
Specifications
www.tfex.co.that 21 Mar 13
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www.tfex.co.that 21 Mar 13
Single Stock Futures Contract
Specifications
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The Specification of Futures ContractsUnderlying asset Particularly for commodity futures, the exchange sets allowable grade
of a commodityDelivery location Place and means of deliveryContract size, e.g. For a crude oil futures contract, 1,000 barrels For the Dow Jones stock index futures, $10 per index point For the SET50 index futures, Baht1,000 per index point For a Eurodollar futures contract, $1 million of a Eurodollar time
depositQuotation Specify how a price of a futures is quoted. E.g. for the CBOT’s corn
futures, prices are quoted in cents per bushel
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The Specification of Futures ContractsDelivery months (expiration months)
The main delivery months for futures are March, June,September and December.
Deliverable or cash settlement contracts
Deliverable contract: settled by delivery of the item
Cash settlement: settled by the payment of cash
Daily price movement limits
Prevent large price movement from speculators.
Position limits
Prevent speculators from having big influence on the market
The max. no. of contracts that an investor may hold.
1010
TFEX’s SET 50 Index Futures
Settlement price (SP): this usually is an average of the prices of the last fewtrades of the day. The settlement price is used to mark-to-market the position.
Volume: A number of contracts traded
Open interest (OI): The number of futures contracts outstanding at any givenin time.
www.tfex.co.th at 13 Jan 2014SET 50 index spot = 880.7
1111
TFEX’s Gold & Single Stock Futures
Gold spot = 19,450
KTB spot = 16.501212
TFEX’s USD and Brent crude Futures
USD spot = 33.02 www.bot.or.th
Brent spot = 106.77*33.02 = 3,525
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AFET’s Futures
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Example of Futures Listing on CBOT
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สินคาอางอิง ทองคําแทงที่มีความบริสุทธิ์ 96.5%
ขนาดของสัญญา 1 สัญญามีขนาดเทากับ ทองคําน้ําหนัก 50 บาท
เดือนที่สัญญาสิ้นสุดอายุ เดือนคู (ก.พ., เม.ย., มิ.ย., ส.ค., ต.ค., ธ.ค.) ใกลที่สุด 3 ลําดับ
ชวงราคาซื้อขายขั้นต่ํา 10 บาท ตอ 1 สัญญา
ชวงการเปลี่ยนแปลงของราคาสูงสุดแตละวัน ไมเกิน + 20 % ของราคาที่ใชชําระราคาในวันทําการกอนหนา
เวลาซื้อขาย Pre-open : 9:15 - 9:45Morning : 9:45 - 12:30 Pre-open : 14:00 - 14:30 Afternoon: 14:30 - 16:55
ราคาทีใ่ช้ชําระในวนัสุดท้าย วันทําการกอนวันทําการสุดทายของเดอืนที่สัญญาสิ้นสุดอายุ โดยในวันนั้น สัญญาที่จะหมดอายุจะซื้อขายไดถึงเวลา 16.30 น.
Gold Futures
1717
ราคา Gold Spot13 มค. 2557
ราคา Gold Futures13 มค. 2557
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กราฟแสดงราคาทองคาํspot กบั ราคาทองคาํฟิวเจอร์ส
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เปรียบเทียบทองคาํ (spot) กบั โกลดฟ์ิวเจอร์ส (futures)ทองคาํ โกลดฟวเจอรส
เงินลงทุน ชําระเงินเต็มมลูคา วางเงินค้ําประกันประมาณ 10%
การสงมอบสินคา สงมอบจริง ชําระเปนเงินสด
กลยุทธการทํากําไร ทํากําไรไดเฉพาะขาขึ้น ทํากําไรไดทั้งขาขึ้นและขาลง
ราคาซื้อขาย ประกาศโดยสมาคมผูคาทอง เปลี่ยนแปลงตลอดวนัตามการซื้อขายในตลาด
ระยะเวลาการลงทุน ระยะกลาง-ยาว ระยะสั้นวันตอวนั
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การทาํกาํไรในตลาดขาขึ้น
กาํไร = 199,000 – 196,000 = 3,000 เงินลงทุน 15,000 กาํไรร้อยละ 20%
ซื้อ มูลคา
196,000
ขาย มูลคา
199,000
เงนิประกนั
GFM10
19,600
19,900
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การทาํกาํไรในตลาดขาลง
กาํไร = 196,000 – 192,500 = 3,500 เงินลงทุน 15,000 กาํไรร้อยละ 23%
ซื้อ มูลคา
192,500
ขาย มูลคา
196,000
GFM10
19,250
19,600
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Clearinghouse The futures exchange provides a clearing mechanism.
Without a clearinghouse, traders will face a counter-partyrisk
With clearing house, each trader only has an obligation withthe clearinghouse
The clearinghouse becomes
The seller of the contract for the long position
The buyer of the contract for the short position
The clearinghouse’s position nets to zero
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Clearinghouse
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Clearinghouse
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Margin Account Since each trader has an obligation with the exchange, and futures
contracts expose to risk of loss.
To protect the exchange from a possible loss on a futures contract, theexchange requires each trader to deposit an initial margin.
The initial margin (deposit) is usually required between 5% to 15% ofthe total value of the contract. For example, for SET50 index futures, theinitial margin is 85,000 per contract, or about 85,000/(1,000*880) = 10.4%.
During the life of a contract, the trader must maintain their accountabove maintenance margin level, e.g., 5% of the total value of thecontract. For SET50 index futures, the maintenance margin is 60,000 percontract, or about 60,000/(1,000*880) = 6.8%.
When falls below the maintenance level, they will receive a margincall and is requested to top up the margin account to the initial marginlevel.
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Daily Settlements (Marking to Market) Furthermore, the profit/loss on a futures contract is settled daily. Winning party
The surplus (above initial margin) from its account can bewithdrawn.
Otherwise, interest is paid on the funds left in this account. Losing party
Additional payments if the value of the position falls belowmaintenance margin
Marking to market can be more than one time per day (i.e.,Intra-day margin call)
For a forward contract, the profit/loss is realized and settled onlyonce at the maturity.
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Example Suppose that the SFE SPI 200 index futures contract is now
traded at 3,500 index points. Its contract size is $25 per indexpoint. The initial and maintenance margins for each contractare 10% and 5% of the value of the contract respectively.
Initial margin = 10% $87,500 (3,500$25 ) = $8,750
Maintenance margin = 5% $87,500 (3,500$25 ) = $4,375
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Day FuturePrice
Daily gain/loss Margin account balance for SHORT positions
Margin call
0123
3,5003,6003,7003,650
-100×25= -$2,500-100×25= -$2,500
50×25= $1,250
$8,750$6,250$3,750
$1,250+$8,750=$10,000
-$5,000
-
Day FuturePrice
Daily gain/loss Margin account balance for LONG positions
Margin call
0123
3,5003,6003,7003,650
100×25= $2,500100×25= $2,500-50×25= -$1,250
$8,750$11,250$13,750$12,500
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Closing Out Positions (Reversing Trading) A trader can close out a position at anytime before the
settlement date. Closing out a long position
taking an a short position on the same contract. A trader bought a June interest rate future contract at 3,200. If in April, the interest rates futures are traded at 3,300. this
trader can close out the position and realise the profit byselling (shorting) the contract.
Closing out a short position taking a long position on the same contract.
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Closing Out Positions and Open Interest The number of contracts outstanding (i.e. number of either
long or short contracts outstanding)
Almost all traders (i.e., about 99%), however, liquidate (i.e.,closeout) their positions before the contract maturity date.
Futures contracts rarely result in actual delivery of theunderlying asset.
The fraction of contracts that result in actual delivery isestimated to range from less than 1 to 3%, depending onthe commodity and the activity in the contract.
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Day FuturePrice
Daily gain/loss Margin account balance for SHORT positions
Margin call
01234
3,5003,6003,7003,6503,600
-100×25= -$2,500-100×25= -$2,500
50×25= $1,25050×25= $1,250
$8,750$6,250$3,750
$1,250+$8,750=$10,000$11,250
-$5,000
-
Day FuturePrice
Daily gain/loss Margin account balance for LONG positions
Margin call
0123
3,5003,6003,7003,650
100×25 = $2,500100×25 = $2,500-50×25= - $1,250
$8,750$11,250$13,750
$12,500 - $12,500
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3,6503,600 -50×25 = -$1,250
$9,125$7,875
The old LONG trader sells the futures contract to a new LONG trader.
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Forward Contracts Versus Futures
Forward contracts
Trade on OTC markets
Not standardized
Specific delivery date
Settled at end of contract
Delivery or final cashsettlement usually takesplace
Futures
Traded on exchanges
Standardized contract
Range of delivery dates
Settled daily
Usually closed out prior tomaturity
The clearinghouse and margin account show how daily settlement and closing-out positions work
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Open Interest and Volume Consider the following example on how to compute open interest and volume.
Time Trading Activity Open Interest
Volume Who are in the market?
Jan 1 A buys 1 futures contract and Bsells 1 futures contract
1 1 A(+1) : B(-1)
Jan 2 E buys 1 futures contract and Asells 1 futures contract
Jan 3 B buys 1 futures contract and Esells 1 futures contract
Time Trading Activity Open Interest
Volume Who are in the market?
Jan 1 A buys 1 futures contract and Bsells 1 futures contract
1 1 A(+1) : B(-1)
Jan 2 C buys 2 futures contracts and Dsells 2 futures contracts
Jan 3 B buys 1 futures contract and Dsells 1 futures contract 34
Open Interest and Volume Consider the following example on how to compute open interest and
volume.
Time Trading Activity Open Interest
Volume Who are in the market?
Jan 1 A buys 1 futures contract and B sells 1 futures contract
1 1 A(+1) : B(-1)
Jan 2 C buys 10 futures contracts and D sells 5 futures contracts and E sells 5 futures contracts
Jan 3 B buys 3 futures contracts and A sells 1 futures contract and C sells 2 futures contracts
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Speculating using Futures and Leverage A crude oil futures contract calls for delivery of 1,000 barrels of
oil. The current future price for delivery in May is $67.15 perbarrel. Suppose the initial margin requirement for the oil contractis 10%.
Expect crude oil prices are going to increase Long oil futures Initial margin = 10%$67,150 ($67.15 1,000 ) = $6,715 If the price of the oil futures increase by $2 ($2/$67.15 = 2.98%) create the gain to the long futures = $21,000 = $2,000 or
2,000/6,715 = 29.8%
Leverage: Ability to take on relatively large exposure to the marketusing futures and options for a relatively small initial outlay.
The 10-to-1 ratio of % change reflects the leverage inherent in the future position.
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Hedging using futuresShort hedges
It is a hedge that involves a short position in futurescontracts
It is used when the hedger already own an asset andexpects to sell it at some time in the future.
Long hedges
It is a hedge that involves a long position in futurescontracts
It is used when the hedger knows it will purchase a certainasset in the futures.
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Example: Hedging using Futures Consider an oil distributor (i.e. hedger) plans to sell 100,000
bbls of oil in May that wishes to hedge against a possibledecline in oil prices. Each oil futures contract calls fordelivery of 1,000 bbls of oil. F0 = $67.15 per barrel.
Hedging strategy: short 100 oil futures contracts
Consider 3 possible spot prices (ST) of oil in May.
- When the spot price (ST) in May is low, the low revenue from spot contract is offset by the profit from the short futures positions- When pt is high, the high revenue is offset by the loss from the short futures.- All cases, end up 6,715,000: elimination risk: uncertain of the spot price.
F0 -ST
ST
ST
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Example: Hedging using Futures
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Forwards/Futures – pricing principle
Should there be any relationship between spot and forward/future prices?
Is forward/futures price a consensus expected spot price at maturity?
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1. Gold: An Arbitrage Opportunity? Suppose that:
The spot price of gold is US$900 The 1-year futures price of gold is US$960 The 1-year US$ interest rate is 5% per annum
Is there an arbitrage opportunity?Action at time 0 Initial Cash
FlowCash Flow at
MaturityBorrow $900 +900 -900(1+0.05)1
Buy gold for $900 -900 ST
Short gold futures at F0=960 0 960 - ST
TOTAL 0 960-900(1+0.05)1 = $15
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2. Gold: Another Arbitrage Opportunity? Suppose that:
The spot price of gold is US$900 The 1-year futures price of gold is US$890 The 1-year US$ interest rate is 5% per annum
Is there an arbitrage opportunity?Action at time 0 Initial Cash
FlowCash Flow at
MaturitySell short gold for $900 +900 -ST
Lend $900 -900 +900(1+1.05)1
Long gold futures at F0=890 0 ST - 890
TOTAL 0 900(1+1.05)1-890 = $5542
The Forward/Futures Price of Gold If the spot price of gold is S and the futures price for a contract deliverable in T
years is F, thenF = S (1+r )T
where r is the 1-year (domestic currency) risk-free interest rate.The continuous version of cost of carry model F = SerT
where r is the 1-year continuously compounded risk-free interest rate.
Future price (relative cost of buying a gold with deferred delivery) = spotprice (cost of buying the gold in the market) and carrying it in inventory.
Cost of carrying gold = risk-free rate If this parity is violated, this can be arbitraged as previously shown. Arbitrage: strategy to exploit the mispricing that will produce a riskless
profit.In our examples, S=900, T=1, and r=0.05 so that
F = 900(1+0.05)1 = 945
Cost-of-carry relationship
$900 is spot cost, and $45 is thecost-of-carry
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3. Oil: An Arbitrage Opportunity?Suppose that:
- The spot price of oil is US$120- The quoted 1-year futures price of oil is US$135- The 1-year US$ interest rate is 5% per annum- The storage cost of oil is $2 per barrel
Is there an arbitrage opportunity?
Action at time 0 Initial Cash Flow
Cash Flow at Maturity
Borrow $120 +120 -120(1+0.05)1
Buy oil for $120 -120 ST
Cost of storing oil 0 -2Short oil futures at F0=135 0 135 - ST
TOTAL 0 135 - 120(1+0.05)1 - 2 = $744
4. Oil: Another Arbitrage Opportunity?Suppose that:
- The spot price of oil is US$120- The quoted 1-year futures price of oil is US$119- The 1-year US$ interest rate is 5% per annum- The storage cost of oil is $2 per barrel
Is there an arbitrage opportunity?
Action at time 0 Initial Cash Flow
Cash Flow at Maturity
Sell short oil for $120 +120 -ST
Lend $120 -120 +120(1+0.05)1
Save cost of storing oil 0 +2Buy oil futures at F0=119 0 ST - 119
TOTAL 0 120(1+0.05)1+2 - 119= $9
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The Forward/Futures Price of Asset with Storage Cost
If the spot price of asset is S and the futures price for a contract deliverable in T years is F, then
F = S (1+r)T + swhere r is the 1-year (domestic currency) risk-free rate of interest,
and s is the dollar storage cost The continuous version of cost of carry model F = Se(r+s)T
where r and s is the 1-year continuously compounded risk-free interest rate and storage cost rate.
Cost of carrying asset = risk-free rate and storage cost If this parity is violated, this can be arbitraged as previously shown.
In our examples, S=120, T=1, r=0.05, and s=$2 so thatF = 120(1+0.05)1 +2 = 128
Cost-of-carry relationship
$120 is spot cost, and $8 isthe cost-of-carry 46
5. Stock Index: An Arbitrage Opportunity?Suppose that:
- The spot price of SET50 index is 450- The quoted 6-month futures price of SET50 is 465- The 1-year Thai Baht interest rate is 5% per annum- The dividends paid from constituent stocks in the SET50 are Baht 5
in the next 6 months Is there an arbitrage opportunity?
Action at time 0 Initial Cash Flow
Cash Flow at Maturity
Borrow $450 +450 -450(1+0.05)1/2
Buy SET50 for $450 -450 ST
Receive dividends 0 +5
Short SET50 futures at F0=465 0 465 - ST
TOTAL 0 465 - 450(1+0.05) 1/2 + 5 = $8.9
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6. Stock Index: An Arbitrage Opportunity?Suppose that:
- The spot price of SET50 index is 450- The quoted 6-month futures price of SET50 is 452- The 1-year Thai Baht interest rate is 5% per annum- The dividends paid from constituent stocks in the SET50 are Baht 5 per
annum Is there an arbitrage opportunity?
Action at time 0 Initial Cash Flow
Cash Flow at Maturity
Sell SET50 for $450 +450 -ST
Lend $450 -450 +450(1+0.05)1/2
Pay dividends 0 -5
Buy SET50 futures at F0=452 0 ST – 452
TOTAL 0 450(1+0.05) 1/2 - 5 – 452 = $4.148
The Forward/Futures Price of Asset with Dividend
If the spot price of asset is S and the futures price for a contract deliverable in T years is F, then
F = S (1+r)T - Dwhere r is the 1-year (domestic currency) risk-free rate of interest,
and D is the dollar amount of dividend paid The continuous version of cost of carry model F = Se(r-d)T
where r and d is the 1-year continuously compounded risk-free interest rate and dividend yield.
Net Cost of carrying asset = risk-free rate minus dividend paid If this parity is violated, this can be arbitraged as previously shown.
In our examples, S=450, T=0.5, r=0.05, and D=$5 so thatF = 450(1+0.05)1/2 - 5 = 456.1
Cost-of-carry relationship
$450 is spot cost, and $6.1 isthe net cost-of-carry
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7. Currency: An Arbitrage Opportunity?Suppose that:
- The spot price of USD is 33 baht- The quoted 1-month futures price of USD is 33.8 baht- The 1-year Thai Baht interest rate is 5% per annum, and the 1-year US$
interest rate is 4% per annum
Is there an arbitrage opportunity?Action at time 0 Initial
Cash FlowCash Flow at Maturity
Borrow 33 baht +33 -33(1+0.05)1/12
Buy USD for 33 baht -33 ST
Receive “dividends” 0 +33(1+0.04)1/12 - 33
Short USD futures at F0=33.8 0 33.8 - ST
TOTAL 0 33.8 – [33(1+0.05) 1/12 -33(1+0.04)1/12 + 33] = .77
US risk-free rate of 4%
Terms in the bracket can beapproximated by 33(1+0.05-0.04)1/12 50
8. Currency: An Arbitrage Opportunity?Suppose that:
- The spot price of USD is 33 baht- The quoted 1-month futures price of USD is 32.8 baht- The 1-year Thai Baht interest rate is 5% per annum, and the 1-year US$
interest rate is 4% per annum
Is there an arbitrage opportunity?Action at time 0 Initial
Cash FlowCash Flow at Maturity
Sell USD for 33 baht +33 -ST
Lend 33 baht -33 +33(1+0.05)1/12
Pay “dividends” 0 - [33(1+0.04)1/12 – 33]
Long USD futures at F0=32.8 0 ST - 32.8
TOTAL 0 [33(1+0.05) 1/12 -33(1+0.04)1/12 + 33] – 32.8 = .23
US risk-free rate of 4%
Terms in the bracket can beapproximated by 33(1+0.05-0.04)1/12
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The Forward/Futures Price of Foreign Currency Assets
If the spot price of asset is S and the futures price for a contract deliverable in T years is F, then
F = S (1 + r - ρ )T
The continuous version of cost of carry model F = Se(r-ρ)T
where r is the 1-year domestic currency risk-free interest rate, and ρ is the foreign currency risk-free interest rate
Net Cost of Carrying asset = domestic risk-free rate minus foreignrisk-free rate
If this parity is violated, this can be arbitraged as previously shown.In our examples, S=33, T=1/12, r=0.05, and d=0.04 so that
F = 33(1+0.05-0.04)1/12 = 33.03
Cost-of-carry relationship
33 is spot cost, and .03 is the net cost-of-carry 52
Futures Markets: Contango vs Backwardation In a Contango market, the futures price exceeds the spot price, that is,
f0(T) > S0. See Table 9.2.
When f0(T) < S0, convenience yield is c , an additional return from holding asset when in short supply/high demand or a non-pecuniary return (e.g., the utility from living in the house owned).
When the commodity has a convenience yield, the futures price may be less than the spot price plus the cost of carry. In that case, the market is said to be at less than full carry and in Backwardation or inverted (See Table 9.3).
Market can be both backwardation and contango --> Table 9.4.
The inability to sell short the asset and the reluctance on the part of holders of the commodity to sell it when its price is higher than it should be can also produce backwardation in commodity markets.
53 5454
www.tfex.co.th
as of 22 March 2013
5555
www.set.or.th, www.tfex.co.th, www.goldtraders.or.th as of 29 March 2013