Delivery and Settlement

Question 1

How does a clearing house manage delivery?

Answer 1

manages contract delivery of open contracts between clearing members and may enable the delivery of documents to represent the underlying assets

Question 2

what are the three options to close out a futures contract?

Answer 2

• 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

Question 3

how is an futures contract closed out before expiry?

Answer 3

by doing an opposing trade in the open market

Question 4

why is closing a futures contract before expiry cheaper?

Answer 4

they don’t have to incur any delivery or storage charges that would occur if the contract went through its delivery process

Question 5

what are the common methods for performing close-outs of futures contracts?

Answer 5

• FIFO (first in first out)
• LFO (last in, first out)
• Max. profit
• Max loss

Question 6

what is FIFO and LIFO?

Answer 6

FIFO: oldest long position against the oldest short position
LIFO: most recent trade, against the oldest position

Question 7

what are the Maximum loss/profit close-out options?

Answer 7

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

Question 8

how is the profit/loss for futures calculated?

Answer 8

= number of ticks moved x tick value x number of contracts

Question 9

how is the tick value calculated?

Answer 9

contract size per point x tick size (e.g., 0.5)

Question 10

what is LMEsword?

Answer 10

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

Question 11

what does LMEsword guarantee?

Answer 11

that the metal the buyer has purchased is of the correct quantity ad quality and that they will have ownership upon payment

Question 12

what are the benefits of LMEsword?

Answer 12

administrative efficiency by removing the physical transfer of warrants

Question 13

what is the EDSP?

Answer 13

Exchnage delivery settlemnt price, closing price set at the last trading day for the contract

Question 14

what does the exchange stipulate at expiry?

Answer 14

rules defining what assets in terms of quality, quantity and location may be finally delivered

Question 15

what is the tender notice?

Answer 15

when futures sellers give notice declaring their intention to deliver the asset to the clearing house for settlement

Question 16

what are the 4 stages of ICE’s delivery procedure?

Answer 16

1. seller advises their intention to deliver
2. universal clearing platform (ICE Connect) matches buyer and seller on a random basis
3. ICE Clear Europe calculate the invoice amount and notify byer and seller
4. seller delivers the asset for payment of amount on the invoice which will be paid by the buyer

Question 17

how is the invoice amount for futures contracts calculated?

Answer 17

= EDSP X scale factor x number of contracts

Question 18

how is the invoice amount for a bond futures contract calculated?

Answer 18

= (EDSP x price factor x scale factor x number of contracts) + accrued interest

Question 19

what does cash settlement allow for?

Answer 19

allows contracts to be based on non-deliverable underlying assets such as a STIR deposit and equity and bond indicies

Question 20

what element is required to settle the trade with cash settlement?

Answer 20

payment of the last day’s variation margin against the EDSP

Question 21

what are the disadvantages/risks associated with Cash settlement?

Answer 21

• 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

Question 22

what does a holder do if they wish to exercise their option?

Answer 22

notify their broker who then fills the exercise notice which is delivered to the clearing house via clearing member

Question 23

what is automatic exercise?

Answer 23

facility operated by ICE Clear Europe and CME Group whereby it will automatically exercise any option that is sufficiently ITM at expiry

Question 24

what are the triggers for an automatic exercise?

Answer 24

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

Question 25

what is a capped-stye option?

Answer 25

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

Question 26

what are the factors involved when creating a control regime for derivatives?

Answer 26

• volume of transactions
• range and complexity of products
• valuations and risk monitoring
• reporting

Question 27

what does the processing and settlement of all transactions include?

Answer 27

• 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)

Question 28

what is the process flow for OTC derivative transactions?

Answer 28

• trade capture and verification
• position keeping and P&L analysis
• confirmation and documentation
• settlement
• reconciliation

Question 29

why must trades be verified immediatly?

Answer 29

because any delay means the market risk and credit risk are not being monitored

Question 30

why must positions be monitored?

Answer 30

for risk control and it directly correlates to profit/loss

Question 31

what is reconcilliation?

Answer 31

process that ensures trades are done within the limits set out by a firm’s trading mandate, matching with client orders