VII: Futures 23: Financial Futures

Chapter 23: Financial Futures © Oltheten & Waspi 2012 Derivative Securities  A derivative is a financial instrument whose underlying security is another financial instrument.  Soybean Futures  The underlying security is soybeans. Soybeans are real so soybean futures are NOT Derivatives  T-Bond Futures  The underlying security is a Treasury Bond (just another piece of paper) so this is a derivative security.

Chapter 23: Financial Futures © Oltheten & Waspi 2012 Index Futures  Index Futures  The underlying security is an Index.  The index is an artificial construct  Dow Jones =13, (October 31,2012)  S&P500 = 1, The number itself means nothing

Chapter 23: Financial Futures © Oltheten & Waspi 2012 Index Futures  The deliverable is cash equal to a multiplier times the index on the delivery date.  The contract definition must include a money multiplier

Chapter 23: Financial Futures © Oltheten & Waspi 2012 DJIA Futures (CBOT)  $10 times index  Settlement: third Friday of the contract month  Cash Settlement  Contracts: March, June, September, & December

Chapter 23: Financial Futures © Oltheten & Waspi 2012 S&P 500 Futures (CME)  $250 times index  Settlement: third Friday of the contract month  Cash Settlement  Contracts: March, June, September, & December

Chapter 23: Financial Futures DJIA ($10) Futures Accessed October 29, 2011 Buy 10 Jun © Oltheten & Waspi 2012

Chapter 23: Financial Futures © Oltheten & Waspi 2012 Example: Buy DJIA Futures  Buy 10 Jun  Promise to buy at 10c * $10 * = $1,203,000.  DJIA currently at 12,  Margin is $10,000 and $8,000 per contract

Chapter 23: Financial Futures BUY 1 DOW JONES $107,970 June 16, 06 Example: Buy DJIA Futures BUY 1 DOW JONES $107,970 June 16, 06 BUY 1 DOW JONES $120,300 Jun 15, 12 BUY $1,203,000 June 15, 2012 © Oltheten & Waspi 2012

Chapter 23: Financial Futures Example: Buy DJIA Futures P S = 12, P F = © Oltheten & Waspi 2012

Chapter 23: Financial Futures BUY 1 DOW JONES $107,970 June 16, 06 Example: Sell DJIA Futures BUY 1 DOW JONES $107,970 June 16, 06 SELL 1 DOW JONES $120,300 Jun 15, 12 SELL $1,203,000 June 15, 2012 © Oltheten & Waspi 2012

Chapter 23: Financial Futures Example: Sell DJIA Futures P S = 12, P F = © Oltheten & Waspi 2012

Chapter 23: Financial Futures © Oltheten & Waspi 2012 Hedging with Index Futures  Buying index futures gives you an investment with a beta of 1  Selling index futures gives you an investment with a beta of –1

Chapter 23: Financial Futures © Oltheten & Waspi 2012 Example: Short Hedge  Portfolio of $2,800,000 with a beta of 1.6  Sell DJIA 11,200 Value per contract Portfolio ValuePortfolio Beta Reduce Beta to 0.80 Number of Contracts

Chapter 23: Financial Futures Hedging with Index Futures April Set HedgePortfolio of Equities$2,800, Sell 20 11,200 [20 * $10 * 11,200 = $2,240,000] - Margin December Lift HedgePortfolio of Equities decreases by 16% Buy 20 10,080 [20 * $10 * 10,080 = $2,016,000] Portfolio Value: Rate of Return: 10% © Oltheten & Waspi 2012

Chapter 23: Financial Futures © Oltheten & Waspi 2012 Example: Short Hedge  Portfolio of $2,800,000 with a beta of 1.6  Sell DJIA 11,200 Value per contract Portfolio Value Portfolio Beta Reduce Beta to 0 Number of Contracts

Chapter 23: Financial Futures Market declines 10% April Set HedgePortfolio of Equities$2,800, Sell [40 * $10 * 11,200 = $4,480,000] - Margin December 2006 Lift HedgePortfolio of Equities decreases by 16% Buy 40 10,080 [40 * $10 * = $4,032,000] Portfolio Value: Rate of Return: © Oltheten & Waspi 2012

Chapter 23: Financial Futures Market increases 10% April Set HedgePortfolio of Equities$2,800, Sell [40 * $10 * = $4,480,000] - Margin December Lift HedgePortfolio of Equities increases by 16% Buy [40 * $10 * = $4,928,000] Portfolio Value: Rate of Return: © Oltheten & Waspi 2012

Chapter 23: Financial Futures Example: Short Hedge (40 contracts) © Oltheten & Waspi 2012 Unhedged Portfolio Hedged Portfolio Futures

Chapter 23: Financial Futures © Oltheten & Waspi 2012 Futures  Futures contracts can be defined around any independently verifiable outcome.

Chapter 23: Financial Futures © Oltheten & Waspi 2012 Class Average Futures  Contract  $1000 * GPA  Initial Margin $4,000  Is a maintenance margin necessary?

Chapter 23: Financial Futures © Oltheten & Waspi 2012 Fin 300 Futures  Last semester Susan and John traded at 3.0  SELL  Price per GPA : 3.0  Name : John  Signature John Q Investor  BUY  Price per GPA : 3.0  Name : Susan  Signature Susan Speculator

Chapter 23: Financial Futures © Oltheten & Waspi 2012 Fin 300 Futures  Last semester Susan and John traded at 3.0  Margin: $4,000  Delivery Value:  Profit/Loss:  Equity:  Margin: $4,000  Delivery Value:  Profit/Loss:  Equity:

Chapter 23: Financial Futures © Oltheten & Waspi 2012 Fin 300 Futures  End of semester GPA was 3.2  Margin: $4,000  Delivery Value:  Profit/Loss:  Equity:  Margin: $4,000  Delivery Value:  Profit/Loss:  Equity:

Chapter 23: Financial Futures © Oltheten & Waspi 2012 Class Average Futures Current Quote: 3.20 Champaign Urbana Futures Exchange

Chapter 23: Financial Futures Class Average Futures © Oltheten & Waspi 2012 Champaign Urbana Futures Exchange

Chapter 23: Financial Futures © Oltheten & Waspi 2012 Futures  Iowa Electronics Market  Presidential Election Market Presidential Election Market 

Chapter 23: Financial Futures Republican Nomination 2012 © Oltheten & Waspi 2012

Chapter 23: Financial Futures Presidential Election 2012 © Oltheten & Waspi 2012

Futures V