Lecture 9: Hedging: Futures market, BAB & SPI Flashcards
What does the future contract specify?
1) Item being traded
2) Future settlement date
3) How the contract can be settled (cash v delivery)
4) Settlement price
What is the short and long position in a contract?
Long position= Person buying
Short position= Person selling
What are deliverable and non- deliverable contracts?
Deliverable= can be settled by exchange of the contract item for the agreed price
Non- deliverable= must be cash settled
How are non- deliverable contracts cash settled?
Through closing out the traders position Long position (buyer) adopts a short position (becomes seller) Short position (seller) adopts a long position (becomes buyer)
What are the three roles of the futures market?
1) Risk transfer function
2) Price discovery
3) Liquidity
How do futures perform the risk- transfer function?
Can HEDGE an exposure to an adverse movement in future spot value
Can SPECULATE on anticipated movements in the spot price
What is the difference between a Forward Rate Agreement and a Future?
Futures are STANDARDISED
- Have standard contracts
- Therefore can be traded in the secondary market
How do futures perform the price discovery function? What is required for this function to be performed?
Perform price discovery by establishing forward priceses as long as the CONTRACTS ARE ACTIVELY TRADED
How do futures create liquid assets?
1) Low cost of trading contract (future contracts themselves are free)
2) Limited amount of settlement dates
3) Standardised contracts
What markets do futures trade in? What was the origional market called and what was traded in this market?
ASX (enforces trading rules)- was the Sydney Futures Exchange- originally a market for wool futures
What kinds of futures are now in the market?
1) 30 day inter-bank cash rate futures
2) 90 day BAB futures
3) 3yr and 10yr bond futures
4) SPI futures
What is the trading system futures are traded on? Who trades on this system and how are trades submitted
Trade 24-
- Brokers submit orders or their on line- trader clients
- Market clearinghouse organises the settlement of trades and mandatory close out on the contract’s settlement date
What is the name of the market clearinghouse for futures?
ASX Clear (Futures)
What does the clearinghouse do?
Two main functions
1) Novation of trades- clearinghouse is the counterparty to each transaction (therefore obligations are only to the clearinghouse)
2) Margin of payments system
What are the two aspects of the margin payment system conducted by ASX clear (futures)
1) Initial margins
2) Daily resettlement
What are initial margins?
Required from both the buyer and seller when position is first traded to open their MARGIN ACCOUNTS
What is daily resettlement?
Further daily margin payments are required from the LOSING SIDE when the balance in the margin account falls below the maintenance level- that is- enough to meet obligations from the loosing position
What is the price quotation of the futures market? What does 94.45 mean as a price?
Means that it will trade at 100- x as the yield
In this case, 5.55% will be the yield
What type of future contract will a borrower of BABs acquired?
Selling BAB futures now & closing out by buying back the BABs
How do we calculate the payout received or payable?
- Calculate the futures price on the day of the initial trade (buy/ sell)
- Calculate the future price on the day of the subsequent trade (sell/ buy)
Calculate the difference (profit or loss) - Calculate actual proceeds received
- Calculate the return- either add or deduct the actual proceeds received from the amount
- Check to ensure that the rate of return is the same as the initial BAB futures rate
What is basis risk?
Basis risk arises when both the BAB coincides with the last day of trading on the BAB futures contracts- if these dates aren’t align= basis risk
Basis risk= the chance the hedge instrument will not precisely manage a risk exposure
What are the two key differences between BABs and FRAs?
1) BAB futures are standardised contracts, whereas FRAs meet the client’s specification
2) BAB futures are traded, wheras FRAs do not have a secondary market
What amounts do BAB futures trade in?
$1m
What do SPI futures enable?
Heding and speculation in the level of the ASX 200
What is the contract unit for an SPI future
$25
How can SPI futures be hedged?
By selling SPI futures
