Chance/BrooksAn Introduction to Derivatives and Risk Management, 8th ed.Ch. 8: 1 Chapter 8: The Structure of Forward and Futures Markets Futures traders tend to be superstitious—when on a good run they are reluctant to change their mojo, this includes washing their jackets. Traders will wear their lucky jackets until they fall apart or their luck runs out. Some traders have even been buried in their lucky jackets, reflecting a hope that the good luck their jackets provided in the trading pits on Earth could be retained for eternity in that Great Trading Pit in the sky. Jim Overdahl Futures Fall Special Issue 2005, p. 14 © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chance/BrooksAn Introduction to Derivatives and Risk Management, 8th ed.Ch. 8: 2 Important Concepts in Chapter 8 n Definitions and examples of forward and futures contracts n Institutional characteristics of forward and futures markets n Futures contracts available for trading n Placing an order, margins, daily settlement n The role of the clearinghouse n Accessing futures price quotations n Magnitude and effects of transaction costs © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chance/BrooksAn Introduction to Derivatives and Risk Management, 8th ed.Ch. 8: 3 Development of Forward and Futures Markets n Chicago Futures Markets n Development of Financial Futures n Development of Options on Futures Markets n Parallel Development of Over-the-Counter Markets u interbank market u growth of forward markets © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chance/BrooksAn Introduction to Derivatives and Risk Management, 8th ed.Ch. 8: 4 Over-the-Counter Forward Market u customized u private u essentially unregulated u credit risk u market size: $64 trillion face value, $840 billion market value at year-end 2007 © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chance/BrooksAn Introduction to Derivatives and Risk Management, 8th ed.Ch. 8: 5 Organized Futures Trading n Contract Development n Contract Terms and Conditions u contract size u quotation unit u minimum price fluctuation u contract grade u trading hours n Delivery Terms u delivery date and time u delivery or cash settlement © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chance/BrooksAn Introduction to Derivatives and Risk Management, 8th ed.Ch. 8: 6 Organized Futures Trading (continued) n Daily Price Limits and Trading Halts u limit moves u circuit breakers n Other Exchange Responsibilities u minimum financial responsibility requirements u position limits u rules governing the trading floor © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chance/BrooksAn Introduction to Derivatives and Risk Management, 8th ed.Ch. 8: 7 Futures Exchanges n See Table 8.1 for list of exchanges. Table 8.1Table 8.1 n Global and after-hours trading n Estimated world-wide volume in 2007 was 7.0 billion contracts. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chance/BrooksAn Introduction to Derivatives and Risk Management, 8th ed.Ch. 8: 8 Futures Traders n General Classes of Futures Traders u futures commission merchants u locals u dual trading n Classification by Trading Strategy u hedger/speculator u spreader u arbitrageur © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chance/BrooksAn Introduction to Derivatives and Risk Management, 8th ed.Ch. 8: 9 Futures Traders (continued) n Classification by Trading Style u scalpers u day traders u position traders n Off-Floor Futures Traders u individuals u institutions u Others: Introducing Broker (IB), Commodity Trading Advisor (CTA), Commodity Pool Operator (CPO), Associated Person (AP) © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chance/BrooksAn Introduction to Derivatives and Risk Management, 8th ed.Ch. 8: 10 Futures Traders (continued) n The Cost and Profitability of Exchange Membership u seats u See Figure 8.1 for history of CME seat prices. Figure 8.1Figure 8.1 u leasing a seat at around %/mo. of seat price u profitability of membership n Forward Market Traders u over-the-counter u primarily institutions © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chance/BrooksAn Introduction to Derivatives and Risk Management, 8th ed.Ch. 8: 11 Mechanics of Futures Trading n Placing an Order u pit u open outcry u electronic systems n The Role of the Clearinghouse u See Figure 8.2. Figure 8.2Figure 8.2 u margin deposits © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chance/BrooksAn Introduction to Derivatives and Risk Management, 8th ed.Ch. 8: 12 Mechanics of Futures Trading (continued) n Daily Settlement u initial margin u maintenance margin u concept of “margin” vs. performance bond u settlement price u variation margin u See Table 8.2 for example. Table 8.2Table 8.2 u open interest © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chance/BrooksAn Introduction to Derivatives and Risk Management, 8th ed.Ch. 8: 13 Mechanics of Futures Trading (continued) n Delivery and Cash Settlement u three-day delivery process u alternative deliverable grades u offsetting u exchange for physicals u forward market procedures © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chance/BrooksAn Introduction to Derivatives and Risk Management, 8th ed.Ch. 8: 14 Futures Price Quotations n Newspapers and web sites © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chance/BrooksAn Introduction to Derivatives and Risk Management, 8th ed.Ch. 8: 15 Types of Futures Contracts n Agricultural Commodities n Natural Resources n Miscellaneous Commodities n Foreign Currencies n Federal funds and Eurodollars n Treasury Notes and Bonds n Equities n Managed Funds n Hedge Funds n Options on Futures © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chance/BrooksAn Introduction to Derivatives and Risk Management, 8th ed.Ch. 8: 16 Transaction Costs in Forward and Futures Trading n Commissions n Bid-Ask Spread n Delivery Costs © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chance/BrooksAn Introduction to Derivatives and Risk Management, 8th ed.Ch. 8: 17 Regulation of Futures Markets n Regulation is nearly always at the federal level; e.g., u Commodity Futures Trading Commission (U.S.) u Financial Services Authority (U.K.) u Financial Services Agency (Japan) n Objective of most federal regulation F ensuring public information available F authorization and licensing of contracts and exchanges F contract approval F market surveillance © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chance/BrooksAn Introduction to Derivatives and Risk Management, 8th ed.Ch. 8: 18 Regulation of Futures Markets (continued) n Arbitration of disputes is sometimes done through the federal government and the courts but often through self- regulatory organizations such as the National Futures Association in the U. S. n Note: Forward markets are regulated only indirectly and, thus, are largely unregulated. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chance/BrooksAn Introduction to Derivatives and Risk Management, 8th ed.Ch. 8: 19 Summary © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chance/BrooksAn Introduction to Derivatives and Risk Management, 8th ed.Ch. 8: 20 Appendix 8: Taxation of Futures Contracts n Treated as 60 % capital gains and 40 % ordinary income. n Capital gains subject to 28 % maximum. n Must be marked to market at year end. n New single stock futures are taxed the same as individual stocks. n Hedge transactions covered in Chapter 11. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chance/BrooksAn Introduction to Derivatives and Risk Management, 8th ed.Ch. 8: 21 (Return to text slide) © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chance/BrooksAn Introduction to Derivatives and Risk Management, 8th ed.Ch. 8: 22 (Return to text slide) © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chance/BrooksAn Introduction to Derivatives and Risk Management, 8th ed.Ch. 8: 23 (Return to text slide) © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chance/BrooksAn Introduction to Derivatives and Risk Management, 8th ed.Ch. 8: 24 (Return to text slide) © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.