Chapter 24
Futures Markets
Investments
© K. Cuthbertson and D. Nitzsche
Derivatives
 Derivatives in finance are used to hedge risk; derive
their value from the volatility of the underlying asset
price (higher volatility = higher value); also called
contingent claims, i. e. value is contingent on the
price of an asset.
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Options
Futures
Forward
Swaps
© K. Cuthbertson and D. Nitzsche
Figure 1 : Derivative markets
OVER-THE-COUNTER
EXCHANGE TRADED
• Supplied by intermediaries
• Traded on exchanges
(banks)
• Customised to suit buyer
• Can be done for any amount,
any settlement date
• Credit risk of counterparty and
expensive to unwind
• Allows anonymity - important
for large deals
• New contracts do not need
approval of regulator
(e.g. NYSE-EuroNext, CBOT,
IMM-CME)
• Available for restricted set of
assets
• Fixed contract sizes and
settlement dates
• Easy to reverse the position
• Credit risk eliminated by
clearing house margining
system (‘marking to market’)
© K. Cuthbertson and D. Nitzsche
Figure 2 : Financial futures
INSTRUMENTS
EXCHANGES
• Money Market Instruments
CBOT
CME
NY Mercantile Exchange,NYMEX
Philadelphia Exchange
Pacific Stock Exchange
3 month Eurodollar deposit,
90 day US T-bills,
3 month Sterling or Euro deposits
• Bonds
US T-bond, German Bund, UK gilts
• Stock Indices
S&P500, FTSE100
• Currencies
Euro, Sterling, Yen, etc.
• Mortgage Pools (GNMA)
© K. Cuthbertson and D. Nitzsche
NYSE-Euronext (was LIFFE)
Singapore, Hong Kong,
Tokyo, Osaka
Sydney Futures Exchange
Figure 1 : Futures (contract specifications)
Commodity
Delivery
Contract
Min. price
change
Daily
limit
1.) US Tbonds
(CBOT)
March,
$ 100,000
$ 31.25
$ 2,000
June, Sept., (8% coupon (=1/32 of 1%) (= 2%)
Dec.
bond)
2.) £-Sterling
(CME-IMM)
Jan.,
£ 125,000
March,
April. June,
July, Sept.,
Oct., Dec.
$ 6.25
(= ½ tick)
None
3.) S&P500
(CBOT)
Next 4
$250 x
months and (S&P500)
March,
June, Sept.,
Dec.
10 points
(0.1) = $ 25
None
Figure 3 : Speculation with futures
Profit per contract
Long future
$10
-$10
F1 = 100
0
F2 = 90
F2 = 110
Futures price
Short future
© K. Cuthbertson and D. Nitzsche
Figure 4 : Newspaper quotes - WSJ
© K. Cuthbertson and D. Nitzsche
Figure 5 : Arbitrage
Stock price
Risk-free rate
Quoted futures price
S = $100
r = 4% p.a.
F90 = $102
Strategy today
Sell futures contract at $102 (receive nothing today)
Borrow $100, buy stock (= synthetic future)
Use no ‘own funds’
3 months time (T = 1/4)
Loan outstanding
= $100 (1+0.04/4) = $101
Deliver stocks, receipt from futures contract = $102
Riskless profit = $1
Homework Arbitrage
Stock price
Risk-free rate
Quoted futures price
Strategy today
3 months time (T = 1/4)
Riskless profit =
S = $100
r = 16% p.a.
F90 = $102
Commodity Futures (carrying cost)
 F=S + carrying cost (non-arbitrage pricing)
 F>S + carrying cost (buy spot; sell Futures =riskless
arbitrage)
 F<S + carrying cost (?)
© K. Cuthbertson and D. Nitzsche