Lecture 9: Hedging: Futures market, BAB & SPI

Question 1

What does the future contract specify?

Answer 1

1) Item being traded
2) Future settlement date
3) How the contract can be settled (cash v delivery)
4) Settlement price

Question 2

What is the short and long position in a contract?

Answer 2

Long position= Person buying

Short position= Person selling

Question 3

What are deliverable and non- deliverable contracts?

Answer 3

Deliverable= can be settled by exchange of the contract item for the agreed price
Non- deliverable= must be cash settled

Question 4

How are non- deliverable contracts cash settled?

Answer 4

Through closing out the traders position 
Long position (buyer) adopts a short position (becomes seller) 
Short position (seller) adopts a long position (becomes buyer)

Question 5

What are the three roles of the futures market?

Answer 5

1) Risk transfer function
2) Price discovery
3) Liquidity

Question 6

How do futures perform the risk- transfer function?

Answer 6

Can HEDGE an exposure to an adverse movement in future spot value
Can SPECULATE on anticipated movements in the spot price

Question 7

What is the difference between a Forward Rate Agreement and a Future?

Answer 7

Futures are STANDARDISED

• Have standard contracts
• Therefore can be traded in the secondary market

Question 8

How do futures perform the price discovery function? What is required for this function to be performed?

Answer 8

Perform price discovery by establishing forward priceses as long as the CONTRACTS ARE ACTIVELY TRADED

Question 9

How do futures create liquid assets?

Answer 9

1) Low cost of trading contract (future contracts themselves are free)
2) Limited amount of settlement dates
3) Standardised contracts

Question 10

What markets do futures trade in? What was the origional market called and what was traded in this market?

Answer 10

ASX (enforces trading rules)- was the Sydney Futures Exchange- originally a market for wool futures

Question 11

What kinds of futures are now in the market?

Answer 11

1) 30 day inter-bank cash rate futures
2) 90 day BAB futures
3) 3yr and 10yr bond futures
4) SPI futures

Question 12

What is the trading system futures are traded on? Who trades on this system and how are trades submitted

Answer 12

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

Question 13

What is the name of the market clearinghouse for futures?

Answer 13

ASX Clear (Futures)

Question 14

What does the clearinghouse do?

Answer 14

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

Question 15

What are the two aspects of the margin payment system conducted by ASX clear (futures)

Answer 15

1) Initial margins

2) Daily resettlement

Question 16

What are initial margins?

Answer 16

Required from both the buyer and seller when position is first traded to open their MARGIN ACCOUNTS

Question 17

What is daily resettlement?

Answer 17

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

Question 18

What is the price quotation of the futures market? What does 94.45 mean as a price?

Answer 18

Means that it will trade at 100- x as the yield

In this case, 5.55% will be the yield

Question 19

What type of future contract will a borrower of BABs acquired?

Answer 19

Selling BAB futures now & closing out by buying back the BABs

Question 20

How do we calculate the payout received or payable?

Answer 20

1. Calculate the futures price on the day of the initial trade (buy/ sell)
2. Calculate the future price on the day of the subsequent trade (sell/ buy)
   Calculate the difference (profit or loss)
3. Calculate actual proceeds received
4. Calculate the return- either add or deduct the actual proceeds received from the amount
5. Check to ensure that the rate of return is the same as the initial BAB futures rate

Question 21

What is basis risk?

Answer 21

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

Question 22

What are the two key differences between BABs and FRAs?

Answer 22

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

Question 23

What amounts do BAB futures trade in?

Answer 23

$1m

Question 24

What do SPI futures enable?

Answer 24

Heding and speculation in the level of the ASX 200

Question 25

What is the contract unit for an SPI future

Answer 25

$25

Question 26

How can SPI futures be hedged?

Answer 26

By selling SPI futures