Chapter 1 and 2 - Futures and Forwards Flashcards
Define “Futures Contracts”
Exchanged traded, standardized (corn, soybeans, oil, etc.), range of delivery dates, settled daily, the contract usually closed out prior to maturity, virtually no credit risk.
How often are futures settled?
They are settled daily using a margin account.
What is a margin account? What is in it?
A margin is cash or marketable securities
deposited by an investor with his or her
broker which is reduced on a daily basis for increases and decreases in the futures contract. They reduce the risk of default. Both buyer and seller post margin.
How are futures contracts settled daily?
They are settled marked to market - cash changes hands every day between the margin accounts. Daily margin cash flows are referred to as variation margin.
What is a maintenance margin?
It is the level at which a trader must replenish their margin account to the initial balance.
What is open interest?
The total number of contracts outstanding (equal to the number of long positions or number of short positions).
What is the settlement price?
The price just before the final bell each day (used for the daily settlement process)
What is volume of trading?
The number of trades in one day.
How do you close out a futures position?
Enter into an offsetting trade. Most contracts are closed out before maturity.
What are the key characteristics of a FORWARD contract?
- OTC traded
- Private contract between two parties
- Non-standard contract
- Not marked to market
- Usually 1 specified delivery date
- Settled at end of contract
- Delivery or final cash settlement usually occurs
- Some credit risk
What are the key characteristics of a FUTURES contract?
- Exchange traded
- Standard contract
- Range of delivery dates
- Settled daily
- Contract usually closed out prior to maturity
- Virtually no credit risk
Define what a derivative is:
A financial contract between 2 parties whose value depends on the value of some other underlying asset. Buyer/seller agrees to buy/sell a specific asset at a specific price on a specific date (legal contract, underlying asset, strike or contract price, an expiration)
Define Open Interest
The total number of contracts outstanding; equal to number of long positions or number of short
positions
Define arbitrage
Earning a return greater than the risk-free rate by holding a portfolio of assets that produce a riskless return
Define law of one price
Two securities with identical future cash flows, regardless of future events, should have the same price (If A and B have the same future payoff, and A is cheaper than B, buy A and sell B to realize a profit)
