Delivery and Settlement Flashcards
How does a clearing house manage delivery?
manages contract delivery of open contracts between clearing members and may enable the delivery of documents to represent the underlying assets
what are the three options to close out a futures contract?
- close it out before expiry
- roll the position forward by closing out the current position and establishing a new position
- proceed to deliver the underlying asset
how is an futures contract closed out before expiry?
by doing an opposing trade in the open market
why is closing a futures contract before expiry cheaper?
they don’t have to incur any delivery or storage charges that would occur if the contract went through its delivery process
what are the common methods for performing close-outs of futures contracts?
- FIFO (first in first out)
- LFO (last in, first out)
- Max. profit
- Max loss
what is FIFO and LIFO?
FIFO: oldest long position against the oldest short position
LIFO: most recent trade, against the oldest position
what are the Maximum loss/profit close-out options?
max profit: equal number of long and short positions to realise the max profit
max loss: equal long and short to realise max loss, reduce build up of credit risk, free up credit lines for further trading
how is the profit/loss for futures calculated?
= number of ticks moved x tick value x number of contracts
how is the tick value calculated?
contract size per point x tick size (e.g., 0.5)
what is LMEsword?
launched in 1999, secure electronic transfer system for LME warrants which are to be held in a central depository, allows for easy delivery since they have approved warehouses around the world
what does LMEsword guarantee?
that the metal the buyer has purchased is of the correct quantity ad quality and that they will have ownership upon payment
what are the benefits of LMEsword?
administrative efficiency by removing the physical transfer of warrants
what is the EDSP?
Exchnage delivery settlemnt price, closing price set at the last trading day for the contract
what does the exchange stipulate at expiry?
rules defining what assets in terms of quality, quantity and location may be finally delivered
what is the tender notice?
when futures sellers give notice declaring their intention to deliver the asset to the clearing house for settlement
what are the 4 stages of ICE’s delivery procedure?
- seller advises their intention to deliver
- universal clearing platform (ICE Connect) matches buyer and seller on a random basis
- ICE Clear Europe calculate the invoice amount and notify byer and seller
- seller delivers the asset for payment of amount on the invoice which will be paid by the buyer
how is the invoice amount for futures contracts calculated?
= EDSP X scale factor x number of contracts
how is the invoice amount for a bond futures contract calculated?
= (EDSP x price factor x scale factor x number of contracts) + accrued interest
what does cash settlement allow for?
allows contracts to be based on non-deliverable underlying assets such as a STIR deposit and equity and bond indicies
what element is required to settle the trade with cash settlement?
payment of the last day’s variation margin against the EDSP
what are the disadvantages/risks associated with Cash settlement?
- doesn’t provide for the delivery of specific index constituents upon delivery
- trading activity of the underlying market may be manipulated by those winding down their contracts and looking to manipulate the EDSP
what does a holder do if they wish to exercise their option?
notify their broker who then fills the exercise notice which is delivered to the clearing house via clearing member
what is automatic exercise?
facility operated by ICE Clear Europe and CME Group whereby it will automatically exercise any option that is sufficiently ITM at expiry
what are the triggers for an automatic exercise?
when the price of the underlying is above are at a certain level for a call or below/at a certain level for a put
what is a capped-stye option?
one that is subject to automatic exercise, have an established profit cap, once the underlying asset’s price has moved beyond that cap and the option is ITM, automatic exercise will take place
what are the factors involved when creating a control regime for derivatives?
- volume of transactions
- range and complexity of products
- valuations and risk monitoring
- reporting
what does the processing and settlement of all transactions include?
- individual deal tickets for the derivatives trades (records all the basic information of the trade)
- any term sheets (outlines what the derivative is actually for, i.e., if it’s a hedge or not)
what is the process flow for OTC derivative transactions?
- trade capture and verification
- position keeping and P&L analysis
- confirmation and documentation
- settlement
- reconciliation
why must trades be verified immediatly?
because any delay means the market risk and credit risk are not being monitored
why must positions be monitored?
for risk control and it directly correlates to profit/loss
what is reconcilliation?
process that ensures trades are done within the limits set out by a firm’s trading mandate, matching with client orders
