Futures and Forwards Flashcards
what four things must be specified in a future or forward contract
- what you are buying or selling (the underlying)
- whether you will buy or sell it (long or short)
- when you will buy or sell it (forward date)
- at what price (forward price)
what is the forward date
specified date of buying or selling in the forward agreemen
what is the spot price
where something is trading at today right now
how are most forwards and futures settled
cash
slope of long position in forward
positive
slope of short position in forward
negative
how is breakeven price determined
by supply and demand, market expectations
what does the bank do with the exposure they take on
find someone on the other side of the bet who has the opposite exposure they would like to spread.
Match the risk
why might an investor use a future or forward for an illiquid asset
selling is hard as illiquid
if the risk will not be long term it is easier to just hedge the risk
why do some investors trade in futures instead of the underlying
- more liquidity, lower transaction costs
- gains exposure to what otherwise isn’t available
- leverage
where are futures traded
over the counter
where are forwards traded
on exchanges
what is the difference between futures and forwards
forwards are customised, futures are standardised
how are forwards customised
private agreement between two parties
specify conditions (price, forward date, amounts)
how are futures standardised
terms and conditions pre made. A finite number o contracts traded on the exchange so you must pick between these predetermined dates and prices etc
who uses forwards
hedgers who may want to specify their own underlying for something there is not a contract for, or determine their own prices
who uses futures
speculators
why choose futures over forwards
cheaper to use as less transaction costs
easier to buy and sell
less credit risk
why do forwards have more credit risk
the full settlement is agreed with the bank or whoever took on the derivative
so if this bank goes bust, no money will be paid out
so eliminating exposure risk but increasing credit risk
what is the credit risk associated with a future
virtually none
you put in a certain amount of money at the start and if this doesn’t cover the worst expected losses, the bank will ring you up to pay
other than this, if you gain money, you can take it out whenevr
what is the margin always equal to in future contract
maximum predicted one day loss
how often is margin calculated
daily
