Intro Futures & Forwards Flashcards
What are forwards and the nature of its trading? Who are their participants?
Agreement between two parties that call for delivery of an asset at a future point in time with a price agreed upon today.
Markets contain default risk. Risk of one party reneging. Contracts are not easily exchangeable due to unique contact arrangements. Participants include hedgers and arbitragers.
What are futures and the nature of its trading? Who are their participants?
A forward contract that had standardised terms, is trade in an organised exchange and follows daily settlement procedures where losses from one party are paid to the other.
Futures markets mitigate the above problems by ring traded in organised exchanges (already standardised and expiry dates set). Participants include hedgers speculators, and arbitrageurs.
What are some advantages and disadvantages of futures?
What are some advantages and disadvantages of forwards?
Advantages:
Leverage: Control large positions with small capital.
Liquidity: Highly liquid markets, easy entry and exit.
Diversification: Access to various asset classes.
Hedging: Protect against adverse price movements.
Price Discovery: Reflects future price expectations.
No Counterparty Risk: Reduced default risk due to daily settlement.
Disadvantages:
Complexity: Requires understanding of advanced concepts.
High Risk: Potential for significant losses.
No Income Generation: No dividends or interest from contracts.
Expiry Date: Contracts require active management or rollover.
Market Volatility: Prices can swing widely.
Potential for Overtrading: Encourages frequent trading, increasing costs.
Who provides a master agreement for OTC forward,?what does a contact over and what does OTC processing involve?
Advantages of Forwards:
Customization: Tailored contract terms.
Hedging: Protects against future price changes.
No Upfront Costs: Typically no initial payment required.
Privacy: Private, confidential agreements.
Simplicity: No margin requirements or daily settlements.
Disadvantages of Forwards:
Counterparty Risk: High default risk.
Illiquidity: Difficult to exit or transfer.
No Standardization: Complicates valuation and trading.
Complexity: Challenging to price accurately.
Settlement Risk: Delivery or payment risk at maturity.
Limited Flexibility: Obligated to fulfill terms regardless of market changes.
What is the clearing house and explain its role?
A clearinghouse is a financial intermediary that ensures the secure and efficient settlement of trades by managing counterparty risk and facilitating the final exchange of assets between buyers and sellers. The ASX is an example of this.
- cover its risk exposure by requiring: initial margins, maintenance margins, marked to market accounting, margins act as a good-faith bond
- Managing Counterparty Risk: Reduces default risk by acting as the intermediary.
- Handling Margin Requirements: Manages margins to cover potential losses.
- Netting Transactions: Offsets buy and sell positions to minimize exchanges.
- Managing Defaults: Utilizes default funds and measures to address defaults.
- Providing Transparency: Reports trades and positions to regulators.
- Ensuring Regulatory Compliance: Adheres to financial regulations.
What is daily settlement also known as? What is a margin call?
A daily settlement is also called the process of marked-to-market. When your balance falls below the maintenance margin you receive a margin call. Additonal funds called variation margin must be provided to the CH.
How can margins be met?
A trader generally has 2 choices to meet the call.
- Top up their account to the initial margin level. This replenishment of funds must be carried out within two business days from the day of the margin call.
- Liquid or some of the contracts. Instead of topping up the trading contract with additional funds, the trader may decide to liquidate (close out) awesome contracts to ensure that their account has sufficient margin to hold the remaining contracts.
Margins can also be met with….
Cash: A broker may require you to provide cash to enable the broker to me their margin obligations to ASX clear.
Collateral: in addition to or as an alternative to cash you may wish (subject to your broker and or ASX clear agreeing) to provide certain types of collateral.
A transaction costs high or low for futures?
Transaction cost for futures markets involve very low trading costs. They are far cheaper than equity /fixed income market, offers more liquidity, brokerage cost, rollover cost no premiums for options margins (initial and maintenance) and these are returned if there is any.
