Chap 15 Flashcards
Cash market
a market where a product or commodity changes hands in exchange for a cash price paid when the transaction is completed.
Futures market
the organized market for the trading of futures contracts.
Futures contract
a commitment to deliver a certain amount of a specified item at a specified date at an agreed-upon price.
Delivery month
much like the expiration date on put and call options; specifies when the commodity or item must be delivered and thus defines the life of the contract.
Differences Futures and Options
Options
- Right to buy
- Strike price specified in option contract
- Up-front cost (premium)
- Loss limited to price paid for option
Futures
- Obligation to buy
- Delivery price set by supply and demand
- No up-front cost
- No limit on potential loss
Open-outcry auction
method once used to conduct floor trading, which required traders to shout their orders while using elaborate hand signals.
Hedgers
businesses that either produce a commodity or use it as an input to their production process.
Producers and processors (futures); Financial institutions and other large corporations (financial futures).
Protect their interests in the underlying commodity or financial instrument.
Make their revenues more predictable by locking in prices, interest rates or exchange rates.
Reason for existence of futures market.
Speculators
trade futures contracts simply to earn a profit on expected price swings.
- Investors
- Provide liquidity
Open interest
Total number of contracts that are open and have not been settled by delivery or offsetting transaction.
Round-trip commissions:
includes the commission costs on both ends of the transaction (to buy and sell contract).
Margin deposit:
Amount deposited with broker at time of commodity transaction to cover any loss in market value of futures contract due to price movements.
-Margin requirements range from 2% to 10%
Maintenance margin:
- Minimum amount of deposit required at all times
- Margin call occurs if value drops below allowed amount
Mark-to-the-market:
an investor’s margin position is checked daily.
Characteristic of Margin trade
- All futures contracts are traded on margin
- No borrowing is required
- Margin deposit
- Maintenance margin
- Mark-to-the-market
Commodities
Physical commodities like grains, wood, and meat make up a major portion of the futures market.
They have been actively traded in this country for well over a century.
Characteristics of Commodities
Commodities are fungible goods that are qualitatively the same regardless of the supplier.
-As long as the underlying commodity meets the contractual standard, it can be traded with futures.
Investors can choose from dozens of commodities in the market for commodity contracts.
Characteristics in a Commodities Contract
- Type of product
- Size of contract (in bushels, pounds, tons)
- Exchange where contract is traded
- Method of valuing contract (e.g., cents per pound, dollars per ton)
- Delivery month
- Settlement price
- Volume
Settlement price:
the last price of the day, or the closing price.
Important since it is used to determine the daily market value of the contract and, therefore, an investor’s profit or loss for the day, as well as margin requirements.
Prior settle: previous day’s settlement price.
Volume
the number of contracts traded for the day.
Price Behavior of commodities
- Commodity prices react to a unique set of economic, political and international pressures, as well as to weather.
- Because we are dealing with such large trading units, even a modest price change can have enormous impact on the market value of a contract and thus investor returns or losses.
- Such price behavior is part of what draws investors to commodities.
Daily price limit (commodities)
restriction on the day-to-day change in price.
Maximum daily price range:
the amount a commodity price can change during the day; usually equal to twice the daily price limit.
Return on invested capital (commodity)
measures the return on a commodities contract.
Return on investment capital = (selling price of commodity contract - purchase price of commodity) / Amount of margin deposit
Forms of investing in commodities:
Speculating
Spreading
Hedging
Speculating (in commodities)
involves using commodities as a way to generate capital gains.
- Try to capitalize on the wide price swings that are characteristic of so many commodities.
- Speculating and spreading are most used by individual investors.
Spreading
futures investors use this trading technique as a way to capture some of the benefits of volatile commodities prices but without all the exposure to loss.
Hedging
in the commodities market is more of a technical strategy that is used almost exclusively by producers and processers to protect a position in a product or commodity.
Financial futures
a segment of the futures market in which futures contracts are traded on financial instruments.
Currency futures
foreign currency contracts.
-Major market currencies such as British pound, Swiss franc, Canadian dollar, Japanese yen, and euro.
Interest rate futures
futures contract on debt securities
U.S. Treasury securities, Federal funds, Interest rate swaps, Euromarket deposits, Foreign government bonds.
Stock index futures
contracts pegged to broad-based measures of stock market performance.
- Dow Jones industrial average
- S&P 500
- Nasdaq 100
- Russell 2000
what contracts use the “Quote system”?
It used by futures is set up to reflect the market value of the contract itself.
Futures options
options that give the holders the right to buy (with calls) or sell (with puts) a single standardized futures contract for a specified period of time at a specified strike price.
On commodities and financial futures
A significant advantage that a futures option has over a futures contract is that the option limits the buyer’s loss exposure to the price of the option.
