8 - Principles of Forwards and Futures Flashcards
what are five key features of the forwards contract?
- contract between two private parties
- non-standard contract
- usually one specific delivery date
- settled at maturity
- delivery of final cash settlement usually occurs
what are five key features of the futures contract?
- exchange traded
- standard contract
- range of delivery dates
- settled daily
- contract usually closed prior to maturity
what are characteristics of the futures price when compared to spot price?
can be above or below the spot price, at maturity they equal the spot price
if the market is efficient what can usually be said about equity instrument prices? what can be said about a forward and futures prices?
“price = value
price = contracted rates of future purchase
therefore price is not = to value”
what is the value of a futures or forwards contract at the beginning?
value = 0
what is the value/price notation for forwards and for futures?
- forward: Vt(0,T), Ft(0,T)
- where 0 is time contract is created and T is time contract expires future: vt(T), ft(T).
what is the forwards price at expiration worth?
F(T,T) = St
meaning the price of a forward contract is equal to the spot price at expiration
what does cost of carry consist of? how is it denoted
“cost of storing asset, plus interest forgone for the period that the asset is held
theta”
on the day before expiry, what is the price of a futures contract equal to? f(T) = 0
futures contract is equal to forwards contract the day before expiry
f(T) = f(t,T)
which three factors have the effect of decreasing the initial value of the spot price one is willing to pay for a futures contract?
- volatility: not being able to estimate what the value will be as expiration i.e. St becomes E(St)
- cost of carry (-s)
- loss of interest on money invested in contract i.e. -Soi
- risk aversion: investors require a risk premium to invest in the contract
So = E(St) - s - Soi - risk premium
what does contango and backwardation mean?
contango= when f(T) > So usually in stable markets backwardation= when f(T) < So
what is normal contango/backwardation? what does it imply?
- Nor Con - f(T) > Expected (St)
- Nor Bac - f(T) < Expected (St)
market consists of speculators
what effects do dividends have on cost of carry?
they reduce the cost of carry
what is the spread of two futures contracts with T1 and T2 to expiry?
the difference in the cost of carry between the two
i.e. theta 2 - theta 1
