1. Investments, 8 th edition Bodie, Kane and Marcus Slides by Susan Hine McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. CHAPTER 22 Futures Markets

2. 22-2 Forward - an agreement calling for a future delivery of an asset at an agreed-upon price Futures - similar to forward but feature formalized and standardized characteristics Key difference in futures –Secondary trading - liquidity –Marked to market –Standardized contract units –Clearinghouse warrants performance Futures and Forwards

3. 22-3 Futures price - agreed-upon price at maturity Long position - agree to purchase Short position - agree to sell Profits on positions at maturity Long = spot minus original futures price Short = original futures price minus spot Key Terms for Futures Contracts

4. 22-4 Figure 22.1 Futures Listings

5. 22-5 Figure 22.2 Profits to Buyers and Sellers of Futures and Option Contracts

6. 22-6 Table 22.1 Sample of Future Contracts

7. 22-7 Clearinghouse - acts as a party to all buyers and sellers –Obligated to deliver or supply delivery Closing out positions –Reversing the trade –Take or make delivery –Most trades are reversed and do not involve actual delivery Open Interest Trading Mechanics

8. 22-8 Figure 22.3 Panel A, Trading without a Clearinghouse. Panel B, Trading with a Clearinghouse

9. 22-9 Initial Margin - funds deposited to provide capital to absorb losses Marking to Market - each day the profits or losses from the new futures price are reflected in the account Maintenance or variation margin - an established value below which a trader’s margin may not fall Margin and Trading Arrangements

10. 22-10 Margin call - when the maintenance margin is reached, broker will ask for additional margin funds Convergence of Price - as maturity approaches the spot and futures price converge Delivery - Actual commodity of a certain grade with a delivery location or for some contracts cash settlement Cash Settlement – some contracts are settled in cash rather than delivery of the underlying assets Margin and Trading Arrangements Continued

11. 22-11 Speculation - –short - believe price will fall –long - believe price will rise Hedging - –long hedge - protecting against a rise in price –short hedge - protecting against a fall in price Trading Strategies

12. 22-12 Basis - the difference between the futures price and the spot price –over time the basis will likely change and will eventually converge Basis Risk - the variability in the basis that will affect profits and/or hedging performance Basis and Basis Risk

13. 22-13 Figure 22.4 Hedging Revenues Using Futures, Example 22.5 (Futures Price = $97.15)

14. 22-14 Spot-futures parity theorem - two ways to acquire an asset for some date in the future Purchase it now and store it Take a long position in futures These two strategies must have the same market determined costs Futures Pricing

15. 22-15 Spot-Futures Parity Theorem With a perfect hedge the futures payoff is certain -- there is no risk A perfect hedge should return the riskless rate of return This relationship can be used to develop futures pricing relationship

16. 22-16 Hedge Example: Section 22.4 Investor owns an S&P 500 fund that has a current value equal to the index of $1,500 Assume dividends of $25 will be paid on the index at the end of the year Assume futures contract that calls for delivery in one year is available for $1,550 Assume the investor hedges by selling or shorting one contract

17. 22-17 Hedge Example Outcomes Value of S T 1,5101,550 1,610 Payoff on Short (1,550 - S T ) 40 0 -60 Dividend Income 25 25 25 Total1,575 1,575 1,575

18. 22-18 Rate of Return for the Hedge

19. 22-19 General Spot-Futures Parity Rearranging terms

20. 22-20 Figure 22.5 S&P 500 Monthly Dividend Yield

21. 22-21 Arbitrage Possibilities If spot-futures parity is not observed, then arbitrage is possible If the futures price is too high, short the futures and acquire the stock by borrowing the money at the risk free rate If the futures price is too low, go long futures, short the stock and invest the proceeds at the risk free rate

22. 22-22 Spread Pricing: Parity for Spreads

23. 22-23 Figure 22.6 Gold Futures Prices

24. 22-24 Theories of Futures Prices Expectations Normal Backwardation Contango Modern Portfolio Theory

25. 22-25 Figure 22.7 Futures Price Over Time, in the Special Case that the Expected Spot Price Remains Unchanged