1. Forward contracts & uses 2. Futures contracts, markets...
Transcript of 1. Forward contracts & uses 2. Futures contracts, markets...
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Topic 4 – Forwards and futures
1. Forward contracts & uses
2. Futures contracts, markets & uses
3. Comparing futures hedge vs forwards hedge
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• Agreement to buy or sell an underlying asset at a fixed
price Ft and on a fixed date T in the future, for defined
grade, quantity & place of delivery.
• Example of a forward contract on t = March 1, 2013 :
1. Forward contracts and uses
1.1. Definition & example
Asset 1 Yellow grain field corn
Nominal amount 50,000 bushels (bu)
Forward price Ft 4.00 USD/bu
Buyer United Grain Brokers Corp.
Seller Corn Grower ltd.
Maturity date May 31, 2013
Place of delivery Saint-Louis City, MO
Commitment to pay
USD 200 000
Commitment to deliver
50 000 bu
Negotiated price
between 2 counterparts
Example of cash bids :
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Ft price
St price
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1.2. Basis evolution
• Basis on t = Ft St
• Considering maturity T = Jan 31, 2013 :
Nov. 7 : basist=0 = 7.62 – 7.29 = + 0.33 USD
Nov. 2 : basist=1 = 7.51 – 7.40 = + 0.11 USD
Nov. 3 : basist=2 = 7.55 – 7.58 = – 0.03 USD
…
Jan. 31 : basist=86 = 0.00 USD
prime
contango
discount
backwardation
Forward price Spot price
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1.3. Using forwards for hedging
1.3.1. Commodity consumer case
• On t, the Kellog’s Co. needs 50,000 bushels of corn, deliverable on T = t + 3 months :
– spot price………………… St = 3.60 USD/bu
– 3 month-forward price…... Ft = 4.00 USD/bu
• Solution 1 :
– buying spot on t
– storage
• Solution 2 :
– buying spot on T
Not risky / carrying cost
Not costly / risky
Solution 3 : buying forward on t for delivery on T :
deposit 3 % on t.…… USD 6 000
settling on T………… USD 200 000 deposit
receiving on T……… 50,000 bu of corn
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ST price increase
price decrease
« l
oss
»
« p
rofi
t »
Ft = 4.00 USD/bu
Effective hedging
Cost of hedging
Forward long position
at maturity :
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1.3.2. Commodity producer case
• On t, a farmer expects a 50,000 bushels corn-crop, deliverable on T = t + 3 months :
– spot price………………… St = 3.60 USD/bu
– 3 month-forward price…… Ft = 4.00 USD/bu
• Solution 1 : selling spot on T
• Solution 2 : selling forward on t for delivery on T
deposit 5 % on t.………… USD 10 000
delivering on T………….. 50,000 bu of corn
receiving on T…………… USD 200 000 + deposit
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gearing
1.4. Using forwards for speculation
• Speculator, owning USD 200 000, expecting a future corn price increase
• Decision on t : buying forward 50,000 bu of corn at a price of Ft = 4.00 USD/bu, settling on T :
deposit on t.……………………….. USD 10 000
settling on T………………………. USD 200 000 deposit
receiving + selling corn on T…….. USD ST 50,000
result on T (in USD)……………… USD (ST – Ft) 50,000
return on T (in %).……………….. (ST – Ft) 50,000 /deposit
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1.5. Using forwards for arbitrage
• On t, an arbitrageur, having a limit of USD 304 000 :
borrows cash…… USD 300 000 at 5⅓ % for 90 days
buys corn spot…. 75,000 bu of corn, paying 270 000 USD
stores corn……... 75,000 bu of corn, paying 20 000 USD
sells corn forward 75,000 bu of corn
• On T, the arbitrageur :
delivers corn…… 75,000 bu
receives cash…… USD 300 000
reimburses……… USD 300 000 + 4 000 USD interests
• « Riskfree » profit on T (locked on t) : USD 6 000
• Numerous arbitrageurs make disappear the profit quickly
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1.6. Forwards features
• About forward contracts :
– high nominal
– effective delivery
– non-tradable on a secundary market
– counterparty risk
• About forward markets :
– major underlying assets : currencies, interest rates, commodities...
– participants : corporations & banks trading the physical asset
– brokers
– quotes & market reports
customized instruments
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Market quotes : USD in London Source : Financial Times, February, 2012.
Bid, offer, mid spot rates & forward rates are derivate from Reuters
Ft,3 months St Ft,1 month Ft,1 year
2. Futures contracts and markets
2.1. Definition and example
• Futures contract :
exchange traded
commitment to
pay/deliver an asset
for a specific time,
place, grade and
quantity.
• Futures price
appears through
trades, for each
maturity.
• Each buyer/seller
faces a margin
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Corn futures quotes
22/11/2012 Pr. Didier Folus 13 USD 5.8975
USD 6.5825
USD 6.4050
Dec 2012 corn futures chart
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Futures use forwards
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2.3. The operation of margins
• CME corn futures (up to Sep 2013) :
– initial margin = USD 2,700 per contract
– maintenance margin = USD 2,000 per contract
• On t = Nov 7, 2012, an operator buys 10 CME SEP13-corn
futures contracts, at USD 6.60 :
– commitment to pay……… 6.60 5 000 10 = USD 330,000
– maturity…………………. # 11 months
– deposit…………………… 2,700 10 = USD 27,000
• The broker/bank opens a margin account
• The CME Clearing operates margins
Margin is a SPAN parameter
Standard Portfolio
Analysis of Risk performance
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Margin account running :
Date Settle
Quote
cents/bu
Daily
result
USD
Margin
account
balance
USD
Margin
call
USD
Cumula-
tive
result
USD
Nov. 7
Nov. 8
Nov. 9
Nov. 11
Nov. 12
660.00
662.00
639.00
636.00
661.00
+ 1 000
11 500
1 500
+ 12 500
27 000
28 000
16 500
18 500
32 500
3 500
1 500
+ 1 000
10 500
12 000
+ 500
Maintenance margin :
USD 2,000 per contract
Futures contracts are
daily marked to market
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2.4. The clearing house
2.4.1. Functions of the clearing house
Authorizing members
Being the counterpart of each transaction
Guaranteeing full termination of operations
Fixing the deposit
Calculating and calling margins, every day
Organizing delivery and settlement
CME Clearing
Nymex Clearing House
LCH.Clearnet Ltd.
NY Clearing Corporation
Depository Trust & Clearing Corporation
Eurex Clearing Ag.
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2.4.2. Rising demand for OTC clearing
• Increasing demand for clearing operations outside the Exchange traded universe
• Ex. : freight derivatives
– strong increase in the business of shipping goods to China
– shipping rate volatility : hurricanes, oil prices…
– freight forwards : OTC traded, cash-settled
• Ex. : IRS, FX, CDS
• OTC facilities :
clearing houses
exchanges
banks
2.5. Market data from Futures Industry Assoc.
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Source : FIA Mag, March 2012.
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Source : FIA Mag, March 2012.
Illustrative case : SG Delta One desk crash
• 2005, 2006 : initially arbitrageur on stock indexes, JK enters into
non-authorized directional positions, using futures for
« small » amounts
• March 2007 : JK enters into a massive short position on futures,
hedging it using fictive long forwards (fictive
counterparties)
• June 2007 : the real P&L shows a latent loss of EUR 2.2 Bn, but
the fictive hedged P&L is close to zero
• Nov 2007 : Eurex warning on the SG position on futures
• Dec 2007 : JK closes the position on futures, making a
EUR 1.4 bn profit, dissimulating it through the fictive
loss on long forwards, the P&L seems to be EUR 55 M.
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Control
Failure…
Control
Failure…
SG Delta One desk crash (the end)
• Jan 2008 : JK enters into a EUR 50 Bn notional long position
using futures (# 30 on DJ Eurostoxx 50, # 18 on Dax,
# 2 on FTSE 100)
• Jan 16, 2008 : « back office » asks for the counterpart id. on forwards
• Jan 18, 2008 : JK lies ; the real P&L shows a EUR 2.7 Bn loss
• Jan 19, 2008 : SGCIB discovers the fraud
• Jan 20, 2008 : SG president decides to close the position immediatly
• Jan 21, 2008 : SG begins to close, in a very bearish market
• Jan 22, 2008 : the real loss equals EUR 6.3 Bn
• Jan 23, 2008 : final net loss equals EUR 4.9 Bn,
SG Board is informed…
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Efficient
Control...
Too late !
947 fictive trades
115 fictive pairs
9 intra-month reserves
Lying emails
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3. Hedging when using futures vs forwards
3.1. Example of a corn grain price risk
• Corn grower on date t = November 7, 2012 :
– expected crop on July 2013………. 20 000 bu
– production cost……………………. 5.00 USD/bu
– storage cost per month…………….. 50 cents/bu
• Hedging decision on t, using futures ?
– corn futures quotes (p. 13)
– buy or sell ?
– which maturity ?
– how many contracts ?
safety & cost ?
flexibility ?
risks ?
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3.2. Hedging using futures : safety & cost
• Shorting four 2013-July futures contracts :
– grower must deliver…...... bu 20,000 of corn
– CME Clearing will pay… 4 5,000 7.30 = USD 146,000
– required deposit….………. USD 4 2,700
– last trading day…………… July 14, 2013
– last delivery day…………. July 16, 2013
– CME Clearing will pay on.. July 31, 2013
• Opportunity cost :
– if ST 730 cents/bu : seller regrets hedging
– if ST 730 cents/bu : hedging avoids a loss
– margin calls cost
Same as forwards
Likely
safer as
forwards
forwards
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3.3. Hedging using futures : flexibility
• If Searly July = 550 cents/bu, the grower will :
harvest the corn
deliver it to the C.H. on T, receiving USD 146,000
net revenue/bu = 730 cents
• If Searly July = 830 cents/bu, the grower could :
sell spot the harvest, receiving USD 166,000
buy 4 futures at Fearly July = 825 cents/bu (supposed futures price)
pay on T : 4 5,000 (7.30 – 8.25) = - 19 000 USD
net revenue/bu = 735 cents Possibility to exit a futures
contract before expiry date
forward contracts
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3.4. Hedging using futures : basis risk
3.4.1. Anticipated delivery
• If crop is early e.g. June 2013 :
– solution 1 : storing + delivering to Clearing House
– solution 2 : selling crop spot + closing futures position
• Solution 1 :
– storing harvest during 1 month…… paying USD 10,000
– delivering harvest in July 2013…… receiving USD 146,000
– net revenue/bu…………………….. 680 cents
Same using
forward contracts
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Solution 2 :
• Early June, grower faces market conditions :
– spot price Searly June = 7.50 cents/bu
– futures quote Fearly June = 7.55 cents/bu
• Grower’s operations early June (date t) :
– delivering harvest, receiving (on t) 20,000 7.50 = 150,000 USD
– clearing futures, paying (on T) 45,000(7.30–7.55) = - 5,000 USD
– revenue = (Ft - (Fearly June - Searly June))nominal = 145,000 USD
• Net revenue = 725 cents/bu (expected : 730 cents/bu)
basis
No basis risk using
forward contracts
3.4.2. Gap between delivery & futures maturity
• If the producer had to hedge an August crop ?
• In November 2012, he/she sells 2013-September contracts
• In August 2013, he/she will :
– harvest & store 1 month, then deliver in Sep to the Clearing House
– harvest & deliver on spot market + close futures position implying
a basis risk
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Futures contracts are not
tailor-made instruments
forward contracts