Futures Markets Historical Considerations Japan 1600's US 1850's CA Winnipeg Market in property rights exchange of PR separated from exchange of commodity Markets for a variety of commodities Grains/oilseeds/livestock/sugar Metals, lumber, oil, Financial instruments Markets are dynamic New products, (lean hog)

Economic Function Institution price discovery transfer of risk - attractive vs. forward contract Why/how did FM develop? Time lag Long distances – slow transport Production/sale Price Uncertainty prices could change rapidly little market information Convenience Trade ownership rights ahead of arrival of commodity Pre-determined price

Why Futures Markets exist Meeting place: Many traders with similar interests (liquidity) Trading rules; enforcement dispute settlement Advantages compared to forward contract Forward - specifications particular Futures: - standardized perfect substitutability of contracts Efficiency gain – lower transactions costs

Market Activity Volume of Trade 580 Million3.1 Billion Value of Trade $12 Trillion$ 39 Trillion # of Contracts # New Contract Filings Electronic Trading 9%78% 8%Agr. Commodities 79%Financials 13%Other Commodity Futures Trading Commission. Performance and Accountability Report., Washington.

Over the Counter Market (OTC) Financial “Swaps” traded by US Commercial Banks since 1981 Poorly regulated Commodity Futures Trading Commission. Performance and Accountability Report., Washington. CFTC estimates this market at $217 Trillion for market meltdown 2010: Congress passed the Dodd-Frank Act bring this market under tighter regulation and oversight as is the case for futures and options markets

Futures: Standardized Contract Contract completely specifies 1 – The good: quantity & quality 2 – Time of expiry delivery month 3 – Location delivery points 4 – Price premia and discounts Specifying the Good - US #2 Corn Federal Grain Inspection Service (USDA) Test Weight56 lbs Moisture13 % Heat Damage (kernels)0.2 % Broken corn 3.0% & foreign matter

Futures: Standardized Contract CBOT Futures Contract Specifications FHKNQUVXZ = Jan, Mar, May, Jul, Aug, Sep, Oct, Nov, Dec

Who is involved in trading ? Clearing house: delivery arrangements - notices to parties contract enforcement contract integrity Members - seat on the exchange - floor traders BrokersIndividuals Users Producers Speculators Exchange: oversight of trading activity trading rules counterparty to all contracts Commodity Futures Trading Commission CFTC “system” oversight

Trading Mechanics (e.g. corn) SELL 1 October contract (short) Right & obligation to SELL $6 in October BUY 1 October contract (long) Right & obligation to BUY $6 in October SELL 1 contract: Market order; limit order, stop loss

Trading Mechanics (e.g. corn) SELL 1 contract: Margin and leverage: % value of contract 5000 $6.00= $ 30,000 10% margin= $ 3000 Price change + 10 cents/bu Margin account “marked to market” Margin = $ $500 = $2500 “paper loss” = $500 Margin call - deposit $ to bring margin to “maintenance margin” BUY 1 contract:“offsets” the SELL contract “crystalize” the loss HOLD 1 contract and deliver at $6.00

Source: Dec 11 Open Interest:1.3 Billion BuUS Corn output (2011) - 12 Billion Bu. Mar 12 Open Interest2.5 Billion Bu Contango Backwardation

Evolution of Trading Volume Sept 11 Corn (CBOT) Contract Expiry

Evolution of Open Interest Dec 11 Corn (CBOT)