Tài chính doanh nghiệp - Lecture 19: Forwards & futures

Lecture 19: Forwards & FuturesFirst Futures Market: Osaka Begun at Dojima, Osaka, Japan, in 1670s. World’s only futures market until 1860s.Dojima was center for rice trade, with 91 rice warehouses in 1673.Dojima futures exchange had precise definitions of quality, delivery date and place, experts who evaluated rice quality, and clearinghouses for contracts.Trading floor, daily resettlement, burning fuse, and watermenFunction of Osaka Futures MarketJapan had sophisticated financial contracts before the futures market, partly under influence of Dutch.Rice bills and silver bills were kinds of forward contracts.Osaka market provided liquidity and price discovery for rice, allows merchants to hedge.Issues for Rice WarehouserWarehousing itself is a stable business, little riskGreat risk in fluctuation in rice priceWarehouser may seek to sell the rice forward and lock in initial price. But, a forward contract is illiquid, difficultForward ContractForward is just a contract to deliver at a future date (exercise date or maturity date) at a specified exercise price.Example: Rice farmer sells rice to warehouser.Example: Foreign Exchange (FX) forward. Contract to sell £ for ¥.Both sides are locked into the contract, no liquidity.What will warehouse think if rice farmer tries to get out of the contract?Problem with Forwards: DefaultFarmer and warehouser must check each others’ creditworthinessForward contracts are inherently credit instruments.Only people with good credit can use them.FX Forwards and Forward Interest ParityFX Forward is like a pair of zero coupon bonds.Therefore, forward rate reflects interest rates in the two currenciesForward Interest Parity:Forward Rate AgreementsPromises interest rate on future loan.L=actual interest rate on contract dateR=contract rateD=days in contract periodA=contract amountB=360 or 365 daysFutures ContractsFutures contracts differ from forward contracts in that contractors deal with an exchange rather than each other, and thus do not need to assess each others’ credit.Futures contracts are standardized retail products, rather than custom products.Futures contracts rely on margin calls to guarantee performance.Buying or Selling FuturesWhen one “buys” a futures contract, one agrees with the exchange to a daily settlement procedure that is only loosely analogous to buying the commodity. One must post initial margin with the futures commission merchant.Usually, one has no intention of taking delivery of the commoditySame as when one “sells” a futures contract, no intention of selling the commodity. Again, post margin.Daily SettlementEvery day, the exchange defines a price called the “settle” price, which is essentially the last trade on that day.Every day until expiration a buyer’s margin account is credited (or debited if negative) with the amount: change in settle price  contract amountIf contract is cash settled, on the last day the margin account is credited with (cash settle price-last settle price)contract amount.If contract is physical delivery, on last day buyer must receive commodityExample: Farmer in IowaFarmer in March is planting crop expected to yield 50,000 bushels of corn. By this business, farmer is “long” 50,000 bushels. Farmer “sells” ten Chicaco September corn contracts for $2.335*$50000 =$116,750. Posts margin.Corn products manufacturer plans to buy corn at harvest time, “buys” the ten contracts, posts margin.Come September, both buyer and seller close out position.Changes in margin account mean that price was effectively locked in at $2.335/bushel for both.Basis RiskBasis risk = risk that Iowa corn prices will not match Chicago settle pricesOption of physical delivery in the corn contract means that arbitrageurs will keep basis risk down.Arbitrageurs may load corn in Iowa and ship to Chicago if Iowa price is below Chicago price. Arbitrageurs activity means farmers don’t have to ship to Chicago.Fair Value in Futures Contractr = interest rates = storage costr+s=cost of carry (See Enforcing Fair ValueIf commodity is in storage, there is a profit opportunity that will tend to drive to zero any difference from fair value.If commodity is not in storage, then it is possible that:Holbrook Working on Futures“Futures” term is misleading, “cash” or “spot transactions sometimes involve deliveries that are further in the futureOnly a few percent of farmers use futuresGrain elevators often serve as risk-managing intermediaries for farmersBut open interest tends to follow inventories in commercial storage, not crop growing in the fields.Essence of futures market is standardization, price discovery, and liquidityExample of Hard Winter Wheat (Holbrook Working)No. 2 Hard Winter Wheat Kansas City Wheat FuturesPlant winter wheat in Fall, harvest in May¾ of US wheat crop is hard.Hard wheat is used for bread, soft wheat for pie crusts, breakfast foods and biscuitsWorking’s Example of Wheat in Storage, Typical YearJuly 2Spot 229 ¼Sept future 232 ¼Spot premium –3Basis 3September 4Spot 232 ½Sept future 233 ½Spot premium –1Basis 1Gain of 2 (reflects gain in premium)Continuing Working’s ExampleSept 4Spot No. 2 232 ½Dec. Future 238 ¼Spot Premium –5 3/4December 12522520Gain of 5 3/4Just Before May HarvestMay 1Spot No. 2 247 ¼July future 229 ¼Spot premium +18July 1Spot No. 2 218 1/2July future 225Spot premium –6 ½Loss of 24 1/2Iowa Electronic MarketsFrom Agricultural Futures to Financial FuturesFinancial futures markets began in US in 1970s.Same concepts of fair value, hedging, gain and loss due to change in basis.