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Financial Markets > Futures Contracts > Flashcards

Futures Contracts Flashcards

1
Q

What are the market participants and what do they do?

A

Hedgers - Hedgers use futures markets for protection against negative price movements.

Speculators – aim to make money from higher or lower prices by taking a view of future price direction.

Arbitrage traders – profit from mispriced instruments by entering and executing a trade.

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2
Q

Define: Futures market

A

a place where market participants
(buyers and sellers) meet to determine the future price of something (underlying asset) today.

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3
Q

Define: Futures contract

A

Instruments which give the holder the opportunity to buy/sell a particular commodity or financial instrument at a predetermined price in the future

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4
Q

How are future contracts used?

A

Used to fix the value of a commodity or financial instrument for the future.

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5
Q

List: Two basic futures positions

A

Long futures position
Short futures position

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6
Q

Explain: Long futures position

A

Buying a futures contract
This will lead to a long position in the market as well

Side note: Hedge against an INCREASE in the price of the underlying

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7
Q

What does it mean when a long futures position is in-the-money?

A

when the underlying spot price price (S) > contract strike price (X) (receives margin)

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8
Q

What does it mean when a long futures position is out-of-the-money?

A

when the underlying spot price price (S) < contract strike price (X) (pays margin)

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9
Q

What does it mean when a long futures position is at-the-money?

A

when the underlying spot price price (S) = contract strike price (X) (neutral)

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10
Q

Explain: Short futures position

A

Selling short a futures contract
This will lead to a short position in the market as well

Side note: Hedge against a DECREASE in the price of the underlying

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11
Q

What does it mean when a short futures position is in-the-money?

A

when the underlying spot price price (S) < contract strike price (X) (receives margin)

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12
Q

What does it mean when a short futures position is out-of-the-money?

A

when the underlying spot price price (S) > contract strike price (X) (pays margin)

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13
Q

What does it mean when a short futures position is at-the-money?

A

when the underlying spot price price (S) = contract strike price (X) (neutral)

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14
Q

List: The two ways to execute a futures contract

A

Offsetting
Making or taking delivery of the underlying instrument (mostly for agricultural commodities)

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15
Q

Explain: Offsetting

A

entering into an opposite position of what you have
(same expiry month, same underlying instrument)

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16
Q

How to close a long futures position?

A

sell a long futures contract

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17
Q

How to close a short futures position?

A

buy back a short futures contract

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18
Q

Define: In-the-money

A

(a) a call option where the asset price is greater than the strike price
(b) a put option where the asset price is less than the strike price.

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19
Q

Define: Out-of-the-money

A

(a) a call option where the asset price is less than the
strike price
(b) a put option where the asset price is greater than the strike price.

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20
Q

Define: At-the-money

A

Where the underlying spot price is equal to the contract strike price (neutral)

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21
Q

Define: Spot price

A

The price for immediate delivery.

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22
Q

Define: Strike price (exercise price)

A

The price at which the asset may be bought or sold in an option contract.

23
Q

Define: Contango

A

is the market condition wherein the price of a
forward or futures contract is trading above the expected spot price at contract maturity – Normal market conditions

24
Q

Define: Backwardation

A

is the market condition wherein the price of a
forward or futures contract is trading below the expected spot price at contract maturity – NOT normal market conditions

25
Q

Define: Initial margin

A

The amount that must be deposited at the time the contract is entered into

26
Q

Define: Variation margin

A

An extra margin required to bring the balance in a margin account up to the initial margin when there is a margin call.

27
Q

What happens when the delivery period for a futures contract approaches?

A

the futures price converges to the spot price of the underlying asset

28
Q

What happens when the delivery period for a futures contract is reached?

A

the futures price equals or is very close to the spot price

29
Q

Why is the futures price equals or is very close to the spot price when the delivery period is reached?

A

the carry cost is reduced over time, causing the
market to “arbitrage” the difference between the futures price and the spot price

30
Q

Explain: Cash settlement

A

The movement on the underlying is payable in cash

31
Q

Explain: Physical settlement

A

The physical underlying asset is exchanged

32
Q

Define: Futures prices (X)

A

is the price at which you agree to buy or sell

33
Q

How is the futures prices determined?

A

It is determined by supply and demand of the underlying in the same way as a spot price

34
Q

Define: Hedging

A

is the process where we reduce or offset the probability of loss from fluctuations in the prices of commodities, currencies, or securities.

35
Q

Define: Hedge ratio

A

The ratio of the size of a position in a hedging instrument to the size of the position being hedged.

36
Q

What are the uses of hedging?

A

it can be used in protecting one’s capital against effects of inflation through investing in high-yield financial instruments, real estate, or precious metals.

37
Q

Define: Hedge effectiveness

A

the proportion of the variance that is eliminated by hedging

38
Q

What are we seeking to get with the hedge effectiveness?

A

seeking a 100% hedge or as close as possible

39
Q

What is h*?

A

optimal hedge ratio

40
Q

What is h* called when it comes to shares?

A

Beta

41
Q

What does beta (h*) measure?

A

measures sensitivity of a share in relation to the market

42
Q

What is the correlation between a portfolio and the market?

A

+1 (tracker fund)

43
Q

What is the beta value (h*) for an all share index (ALSI)?

A

1

44
Q

Define: Basis risk

A

the uncertainty as to the difference between the spot price and the futures price

45
Q

When are we exposed to basis risk?

A

When using different futures contracts to hedge other assets

46
Q

Profit or loss:When is profit or loss made?

A

When the position is closed

47
Q

Profit or loss: When will the money in the variation account translate into a profit or loss?

A

The money in the variation margin account will translate into a profit/loss when the position is closed out

48
Q

Rolling positions: When can profit or loss be made?

A

The profit/loss can only be made on current open positions (long or short)

49
Q

Rolling positions: When does the profit or loss position resets?

A

Once the position is “rolled” to a following contract month, the P/L position resets and will be calculated on the new contract month

50
Q

Buying or selling the spread: List the two types of spreads

A

Calendar spreads
Inter-commodity spreads

51
Q

Buying or selling the spread: Explain calendar spreads

A

The difference between two contract months

52
Q

Buying or selling the spread: Explain inter-commodity spreads

A

The difference between two different
commodities/assets

53
Q

Buying or selling the spread: How do you choose the positions of two assets (A & B) when buying the spread?

A

a long position is taken in asset A while a short position is taken in asset B

Financial Markets (6 decks)

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