1. VII: Futures 23: Financial Futures

2. 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.

3. 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 =13,096.36 (October 31,2012)  S&P500 = 1,412.16 The number itself means nothing

4. 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

5. 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

6. 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

7. Chapter 23: Financial Futures DJIA ($10) Futures http://www.cmegroup.com/trading/equity-index/us-index/dow.html Accessed October 29, 2011 Buy 10 Jun 12 @ 12030.0 © Oltheten & Waspi 2012

8. Chapter 23: Financial Futures © Oltheten & Waspi 2012 Example: Buy DJIA Futures  Buy 10 Jun 12 @ 12030  Promise to buy at 10c * $10 * 12030 = $1,203,000.  DJIA currently at 12,231.11  Margin is $10,000 and $8,000 per contract

9. Chapter 23: Financial Futures BUY 1 DOW JONES INDEX @ 10797 $107,970 June 16, 06 Example: Buy DJIA Futures BUY 1 DOW JONES INDEX @ 10797 $107,970 June 16, 06 BUY 1 DOW JONES INDEX @ 12030 $120,300 Jun 15, 12 BUY 10 DJIAs @ 12030 $1,203,000 June 15, 2012 © Oltheten & Waspi 2012

10. Chapter 23: Financial Futures Example: Buy DJIA Futures P S = 12,231.11 P F = 12030 © Oltheten & Waspi 2012

11. Chapter 23: Financial Futures BUY 1 DOW JONES INDEX @ 10797 $107,970 June 16, 06 Example: Sell DJIA Futures BUY 1 DOW JONES INDEX @ 10797 $107,970 June 16, 06 SELL 1 DOW JONES INDEX @ 12030 $120,300 Jun 15, 12 SELL 10 DJIAs @ 12030 $1,203,000 June 15, 2012 © Oltheten & Waspi 2012

12. Chapter 23: Financial Futures Example: Sell DJIA Futures P S = 12,231.11 P F = 12030 © Oltheten & Waspi 2012

13. 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

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

15. Chapter 23: Financial Futures Hedging with Index Futures April Set HedgePortfolio of Equities$2,800,000.00 Sell 20 Dec @ 11,200 [20 * $10 * 11,200 = $2,240,000] - Margin December Lift HedgePortfolio of Equities decreases by 16% Buy 20 Dec @ 10,080 [20 * $10 * 10,080 = $2,016,000] Portfolio Value: Rate of Return: 10% © Oltheten & Waspi 2012

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

17. Chapter 23: Financial Futures Market declines 10% April Set HedgePortfolio of Equities$2,800,000.00 Sell 40 Dec @ 11200 [40 * $10 * 11,200 = $4,480,000] - Margin December 2006 Lift HedgePortfolio of Equities decreases by 16% Buy 40 Dec @ 10,080 [40 * $10 * 10080 = $4,032,000] Portfolio Value: Rate of Return: © Oltheten & Waspi 2012

18. Chapter 23: Financial Futures Market increases 10% April Set HedgePortfolio of Equities$2,800,000.00 Sell 40 Dec @ 11200 [40 * $10 * 11200 = $4,480,000] - Margin December Lift HedgePortfolio of Equities increases by 16% Buy 40 Dec @ 12320 [40 * $10 * 123200 = $4,928,000] Portfolio Value: Rate of Return: © Oltheten & Waspi 2012

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

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

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

22. 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

23. 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:

24. 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:

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

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

27. Chapter 23: Financial Futures © Oltheten & Waspi 2012 Futures  Iowa Electronics Market  Presidential Election Market Presidential Election Market  http://tippie.uiowa.edu/iem/

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

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

30. Futures V