Assignment 2 Chapter 8

8/10/2019 Assignment 2 Chapter 8

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Assignment 2Chapter 8

Major Futures Exchanges Margin Requirements &

Types of Underlying Assets

Hatem Hassan Zakaria


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A.Futures contract

A.Definition

a futures contract(more colloquially, futures) is a standardized contract between twoparties to buy or sell a specified asset of standardized quantity and quality for a priceagreed upon today (thefutures price) with delivery and payment occurring at a specifiedfuture date, the delivery date, making it a type of derivative instrument. The contracts arenegotiated at a futures exchange, which acts as an intermediary between the two parties.The party agreeing to buy the underlying asset in the future, the "buyer" of the contract, issaid to be "long", and the party agreeing to sell the asset in the future, the "seller" of thecontract, is said to be "short".

While the futures contract specifies a trade taking place in the future, the purpose of thefutures exchange institution is to act as intermediary and minimize the risk of default byeither party. Thus the exchange requires both parties to put up an initial amount of cash(performance bond), the margin.

Additionally, since the futures price will generally change daily, the difference in theprior agreed-upon price and the daily futures price is settled daily also (variation margin).The exchange will draw money out of one party's margin account and put it into theother's so that each party has the appropriate daily loss or profit. If the margin accountgoes below a certain value, then a margin call is made and the account owner mustreplenish the margin account.

This process is known as marking to market. Thus on the delivery date, the amountexchanged is not the specified price on the contract but the spot value (i.e. the originalvalue agreed upon, since any gain or loss has already been previously settled by markingto market).

A closely related contract is a forward contract. A forward is like a futures in that itspecifies the exchange of goods for a specified price at a specified future date. However,a forward is not traded on an exchange and thus does not have the interim partialpayments due to marking to market. Nor is the contract standardized, as on the exchange.

Unlike an option, both parties of a futures contract must fulfill the contract on thedelivery date. The seller delivers the underlying asset to the buyer, or, if it is a cash-settled futures contract, then cash is transferred from the futures trader who sustained aloss to the one who made a profit. To exit the commitment prior to the settlement date,the holder of a futures position can close out its contract obligations by taking theopposite position on another futures contract on the same asset and settlement date. Thedifference in futures prices is then a profit or loss.


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Future contracts are also agreements between two parties in which the buyer agrees to

buy an underlying asset from the other party (the seller). The delivery of the asset occurs

at a later time, but the price is determined at the time of purchase.

Terms and conditions are standardized. Trading takes place on a formal exchange wherein the exchange provides a place

to engage in these transactions and sets a mechanism for the parties to trade these

contracts.

There is no default risk because the exchange acts as a counterparty, guaranteeing

delivery and payment by use of a clearing house.

The clearing house protects itself from default by requiring its counterparties to

settle gains and losses or mark to market their positions on a daily basis.

Futures are highly standardized, have deep liquidity in their markets and trade on

an exchange.

An investor can offset his or her future position by engaging in an opposite

transaction before the stated maturity of the contract.

Example: Future Contracts

Let's assume that in September the spot or current price for hydroponic tomatoes is $3.25per bushel and the futures price is $3.50. A tomato farmer is trying to secure a selling

price for his next crop, while McDonald's is trying to secure a buying price in order todetermine how much to charge for a Big Mac next year. The farmer and the corporationcan enter into a futures contract requiring the delivery of 5 million bushels of tomatoes toMcDonald's in December at a price of $3.50 per bushel. The contract locks in a price forboth parties. It is this contract - and not the grain per se - that can then be bought and soldin the futures market.

In this scenario, the farmer is the holder of the short position (he has agreed to sell theunderlying asset - tomatoes) and McDonald's is the holder of the long position (it hasagreed to buy the asset). The price of the contract is 5 million bushels at $3.50 per bushel.


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B.Types of Futures contracts Underlying assets

Depending on the type of underlying asset, there are different types of futures contract

available for trading. They are

Individual stock futures.

Stock index futures.

Commodity futures.

Currency futures.

Interest rate futures.

A. INDIVIDUAL STOCK FUTURES

Individual stock futures are the simplest of all derivative instruments.

B. STOCK INDEX FUTURES.

Understanding stock index futures is quite simple if you have understood individual stock

futures. Here the underlying asset is the stock index. For example the S&P CNX Niftypopularly called the nifty futures. Stock index futures are more useful when speculating

on the general direction of the market rather than the direction of a particular stock. It can

also be used to hedge and protect a portfolio of shares. So here, the price movement of

an index is tracked and speculated. One more point to note here is that, although stock

index is traded as an asset, it cannot be delivered to a buyer. Hence, it is always cash

settled.

Both individual stock futures and index futures are traded in the NSE.
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C. COMMODITY FUTURES

Its the same as individual stock futures. The underlying asset however would be a

commodity like gold or silver. In India, Commodity futures are mainly traded in two

exchanges1. MCX (Multi commodity exchange) and NCDEX (National commodities

and derivatives exchange). Unlike stock market futures where a lot of parameters are

measured, the commodity market is predominantly driven by demand and supply.

The term commodity is a very broad term and it includes

Bulliongold and silver

MetalsAluminum , copper, lead, iron, steel, nickel, tin, zinc

Energy-crude oil, gasoline, heating oil, electricity, natural gas

Weather- carbon

Oil and oil seedscrude palm oil, kapsica khali,refined Soya oil, Soya bean Cereals- barley, wheat, maize

Fiber- cotton, kapas

Species-cardamom, coriander, termuric etc

Pluseschana

Others- like potatoes, sugar, almonds, gaur

D. CURRENCY FUTURES.

The MCX-SX exchange trades the following currency futures:

Euro-Indian Rupee (EURINR),

Us dollar-Indian rupee (USDINR),

Pound Sterling-Indian Rupee (GBPINR) and

Japanese Yen-Indian Rupee (JPYINR).

E. INTEREST RATE FUTURES.

Interest rate futures are traded on the NSC. These are futures based on interest rates. In

India, interest rates futures were introduced on August 31, 2009.The logic of underlyingasset is the same as we saw in commodity or stock futuresin this case , the underlying

asset would be a debt obligationdebts that move in value according to changes in

interest rates (generally government bonds). Companies, banks, foreign institutional

investors, non-resident Indian and retail investors can trade in interest rate

futures. Buying an interest rate futures contract will allow the buyer to lock in a future

investment rate.


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FROM WEATHER TO TERROR..!!

Weather influences everyones lives. Right from daily lives to agriculture to corporate

earningseverything gets affected if the weather is not favorable. For examplelets

assume that this year cold winter is expected in most parts of the United States. What

happens is that the price of heating oil goes up. Heating oil futures are traded in

commodity markets depending on weather forecasts.

The fear of terrorist strikes had even made Pentagon think of creating a futures market to

help predict terrorist strikes. Their theory was that possibility of terror strikes in a

particular areafor example possibility of a terror strike in New York would be traded as

if it was a commodity. Higher the price, higher the possibilities of a terror strike. This

way they thought, would help them in finding potential threats.

Or take another examplethe assassination of Israel prime minister futures whichwould be available for trade as a commodity. Higher the price, the more likely the event.

1. Derivatives - Futures vs. Forwards

Futures differ from forwards in several instances:

A.

A forward contract is a private transaction - a futures contract is not. Futures

contracts are reported to the future's exchange, the clearing house and at least one

regulatory agency. The price is recorded and available from pricing services.

B. A future takes place on an organized exchange where the all of the contract's

terms and conditions, except price, are formalized. Forwards are customized to

meet the user's special needs. The future's standardization helps to create liquidity

in the marketplace enabling participants to close out positions before expiration.

C. Forwards have credit risk, but futures do not because a clearing house guarantees

against default risk by taking both sides of the trade and marking to market theirpositions every night. Mark to market is the process of converting daily gains and

losses into actual cash gains and losses each night. As one party loses on the trade

the other party gains, and the clearing house moves the payments for the

counterparty through this process.


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D. Forwards are basically unregulated, while future contract are regulated at the

federal government level. The regulation is there to ensure that no manipulation

occurs, that trades are reported in a timely manner and that the professionals in

the market are qualified and honest.

2. Characteristics of Futures Contracts

In a futures contract there are two parties:

A. The long position, or buyer, agrees to purchase the underlying at a later date or at

the expiration date at a price that is agreed to at the beginning of the transaction.

Buyers benefit from price increases.

B. The short position, or seller, agrees to sell the underlying at a later date or at the

expiration date at a price that is agreed to at the beginning of the transaction.

Sellers benefit from price decreases.

Prices change daily in the marketplace and are marked to market on a daily basis.

At expiration, the buyer takes delivery of the underlying from the seller or the parties can

agree to make a cash settlement.

C.

Initial Margin in Major Futures Exchanges

The percentage of the purchase price of securities (that can be purchased on

margin) that the investor must pay for with his or her own cash or marginable

securities.

Also called the "initial margin requirement."

In the futures market,margin has a definition distinct from its definition in the stock

market, where margin is the use of borrowed money to purchase securities. In the futures

market, margin refers to the initial deposit of "good faith"made into an account in order

to enter into a futures contract. This margin is referred to as good faith because it is this

money that is used to debit any day-to-day losses.

When you open a futures contract, the futures exchange will state a minimum amount of

money that you must deposit into your account.
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This original deposit of money is called theinitial margin.When your contract is

liquidated,you will be refunded the initial margin plus or minus any gains or losses that

occur over the span of the futures contract. In other words, the amount in your margin

account changes daily as the market fluctuates in relation to your futures contract. The

minimum-level margin is determined by the futures exchange and is usually 5% to 10%

of the futures contract. These predetermined initial margin amounts are continuously

under review: at times of high market volatility, initial margin requirements can be

raised.

The initial margin is the minimum amount required to enter into a new futures contract,

but themaintenance margin is the lowest amount an account can reach before needing to

be replenished. For example, if your margin account drops to a certain level because of a

series of daily losses, brokers are required to make amargin call and request that youmake an additional deposit into your account to bring the margin back up to the initial

amount.

Let's say that you had to deposit an initial margin of $1,000 on a contract and the

maintenance margin level is $500. A series of losses dropped the value of your account to

$400. This would then prompt the broker to make a margin call to you, requesting a

deposit of at least an additional $600 to bring the account back up to the initial margin

level of $1,000.

Word to the wise: when a margin call is made, the funds usually have to be delivered

immediately. If they are not, the brokerage can have the right to liquidate your position

completely in order to make up for any losses it may have incurred on your behalf.

Leverage: The Double-Edged Sword

In the futures market,leverage refers to having control over large cash amounts of

commodities with comparatively small levels of capital. In other words, with a relatively

small amount of cash, you can enter into a futures contract that is worth much more thanyou initially have to pay (deposit into your margin account). It is said that in the futures

market, more than any other form of investment, price changes are highly leveraged,

meaning a small change in a futures price can translate into a huge gain or loss.
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Futures positions are highly leveraged because the initial margins that are set by the

exchanges are relatively small compared to the cash value of the contracts in question

(which is part of the reason why the futures market is useful but also very risky). The

smaller the margin in relation to the cash value of the futures contract, the higher the

leverage. So for an initial margin of $5,000, you may be able to enter into a long position

in a futures contract for 30,000 pounds of coffee valued at $50,000, which would be

considered highly leveraged investments.

You already know that the futures market can be extremely risky and, therefore, not for

the faint of heart. This should become more obvious once you understand the arithmetic

of leverage. Highly leveraged investments can produce two results: great profits or

greater losses.As a result of leverage, if the price of the futures contract moves up even slightly, the

profit gain will be large in comparison to the initial margin. However, if the price just

inches downwards, that same high leverage will yield huge losses in comparison to the

initial margin deposit. For example, say that in anticipation of a rise in stock prices across

the board, you buy a futures contract with a margin deposit of $10,000, for an index

currently standing at 1300. The value of the contract is worth $250 times the index (e.g.

$250 x 1300 = $325,000), meaning that for every point gain or loss, $250 will be gained

or lost.

If after a couple of months, the index realized a gain of 5%, this would mean the index

gained 65 points to stand at 1365. In terms of money, this would mean that you as an

investor earned a profit of $16,250 (65 points x $250); a profit of 162%!

On the other hand, if the index declined 5%, it would result in a monetary loss of $16,250

- a huge amount compared to the initial margin deposit made to obtain the contract. This

means you still have to pay $6,250 out of your pocket to cover your losses. The fact that a

small change of 5% to the index could result in such a large profit or loss to the investor(sometimes even more than the initial investment made) is the risky arithmetic of

leverage. Consequently, while the value of a commodity or a financial instrument may

not exhibit very much price volatility, the same percentage gains and losses are much

more dramatic in futures contracts due to low margins and high leverage.


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Pricing and Limits

contracts in the futures market are a result of competitive price discovery. Prices are

quoted, as they would be in the cash market: in dollars and cents or per unit (gold ounces,

bushels, barrels, index points, percentages and so on).

Prices on futures contracts, however, have a minimum amount that they can move. These

minimums are established by the futures exchanges and are known as "ticks." For

example, the minimum sum that a bushel of grain can move upwards or downwards is a

quarter of one U.S. cent. For futures investors, it's important to understand how the

minimum price movement for each commodity will affect the size of the contract inquestion. If you had a wheat contract for 5,000 bushels, the minimum price movement

would be $12.50 ($0.0025 x 5,000).

Futures prices also have a price change limit that determines the prices between which

the contracts can trade on a daily basis. The price change limit is added to and subtracted

from the previous day's close and the results remain the upper and lower price boundary

for the day.

Say that the price change limit on silver per ounce is $0.25. Yesterday, the price per

ounce closed at $5. Today's upper price boundary for silver would be $5.25 and the lower

boundary would be $4.75. If at any moment during the day the price of futures contracts

for silver reaches either boundary, the exchange shuts down all trading of silver futures

for the day. The next day, the new boundaries are again calculated by adding and

subtracting $0.25 to the previous day's close. Each day the silver ounce could increase or

decrease by $0.25 until an equilibrium price is found. Because trading shuts down if

prices reach their daily limits, there may be occasions when it is NOT possible to

liquidate an existing futures position at will.

The exchange can revise this price limit if it feels it's necessary. It's not uncommon for

the exchange to abolish daily price limits in the month that the contract expires (delivery

or "spot"month). This is because trading is often volatile during this month, as sellers

and buyers try to obtain the best price possible before the expiration of the contract.
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In order to avoid any unfair advantages, the CTFC and the futures exchanges impose

limits on the total amount of contracts or units of a commodity in which any single

person can invest. These are known as position limits and they ensure that no one person

can control the market price for a particular commodity.

Commodity Futures

Product

Client Margin Clearing HouseMargin

Initial Maintenance

(US$) (US$) (US$)

Gold Futures Full Rate 4,810 3,850 3,850

(/lot)

Spread Rate 1,450 1,160 1,160

(/spread)

Currency Futures

Product


Initial Maintenance

(RMB) (RMB) (RMB)USD/CNH Futures Full Rate 15,510 12,410 12,410

(/lot)

Spread Rate 9,310 7,450 7,450

(/spread)

Spot Month Charge 3,110 2,490 2,490

(/lot)


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Index Futures

Product


Initial Maintenance

(HK$) (HK$) (HK$)

Hang Seng Index Futures Full Rate 93,750 75,000 75,000

(/lot)

Spread Rate 18,750 15,000 15,000

(/spread)

Mini-Hang Seng Index Futures Full Rate 18,750 15,000 15,000

(/lot)

Spread Rate 3,750 3,000 3,000

(/spread)

H-share Index Futures Full Rate 41,250 33,000 32,950

(/lot)

Spread Rate 12,400 9,900 9,900

(/spread)

Mini-H-share Index Futures Full Rate 8,250 6,600 6,590

(/lot)

Spread Rate 2,480 1,980 1,980

(/spread)

CES China 120 Index Futures Full Rate 12,930 10,340 10,340

(/lot)

Spread Rate 3,880 3,110 3,110

(/spread)

HSCEI Dividend Point Index Futures Full Rate 2,230 1,780 1,780

(/lot)

Spread Rate 2,680 2,140 2,140

(/spread)

HSI Dividend Point Index Futures Full Rate 4,570 3,650 3,650

(/lot)

Spread Rate 5,490 4,380 4,380

(/spread)

HSI Volatility Index Futures Full Rate 24,660 19,730 19,730

(/lot)

Spread Rate 7,400 5,920 5,920

(/spread)

IBOVESPA Futures Full Rate 18,690 14,950 14,950

(/lot)

Spread Rate 5,610 4,490 4,490

(/spread)


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S&P BSE Sensex Index Futures Full Rate 16,510 13,210 13,210

(/lot)

Spread Rate 4,960 3,970 3,970

(/spread)

FTSE/JSE Top40 Futures Full Rate 28,970 23,180 23,180

(/lot)

Spread Rate 8,700 6,960 6,960

(/spread)

MICEX Index Futures Full Rate 16,390 13,110 13,110

(/lot)

Spread Rate 4,920 3,940 3,940

(/spread)

Interest Rate Futures

Product


Initial Maintenance

(HK$) (HK$) (HK$)

Three-year Exchange Fund Note (EFN)Futures

Full Rate 11,350 9,080 8,570

(/lot)

Spread Rate 3,410 2,730 2,580

(/spread)

One-Month HIBOR Futures Full Rate 272 217 207

(/lot)

Three-Month HIBOR Futures Full Rate 1,030 822 779

(/lot)


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Stock Futures

Product


Initial Maintenance

(HK$) (HK$) (HK$)

iShares FTSE A50 China Index ETF Futures Full Rate 2,840 2,270 2,270

(/lot)

Spread Rate 852 681 681

(/spread)

Aluminum Corporation of China Ltd. Futures Full Rate 822 658 621

(/lot)


(/spread)

China AMC CSI 300 index ETF Futures Full Rate 3,760 3,010 3,010

(/lot)

Spread Rate 1,130 903 903

(/spread)

Bank of China Ltd. Futures Full Rate 229 183 183

(/lot)


(/spread)

Bank of Communications Co. Ltd. Futures Full Rate 355 284 284

(/lot)


(/spread)

The Bank of East Asia Limited Futures Full Rate 420 336 336

(/lot)


(/spread)

BOC Hong Kong (Holdings) Ltd. Futures Full Rate 807 645 645

(/lot)


(/spread)

China Construction Bank Corporation Futures Full Rate 366 293 293

(/lot)


(/spread)

China Communications Construction Co.Limited Futures

Full Rate 373 298 298

(/lot)


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(/spread)

China Mobile Limited Futures Full Rate 3,620 2,900 2,750

(/lot)


(/spread)

China Unicom (Hong Kong) Limited Futures Full Rate 2,070 1,660 1,570

(/lot)


(/spread)

CITIC Limited Futures Full Rate 1,230 984 921

(/lot)


(/spread)

Cheung Kong (Holdings) Limited Futures

(CKH - Multiplier = 1,000)

Full Rate 9,190 7,360 7,350

(/lot)

Spread Rate 2,760 2,210 2,210

(/spread)

Cheung Kong (Holdings) Limited Futures(CKA - Multiplier = 1,055)

Full Rate 9,697 7,766 7,756

(/lot)

Spread Rate 2,912 2,332 2,332

(/spread)

China Life Insurance Co. Ltd. Futures Full Rate 1,430 1,150 1,140

(/lot)


(/spread)

CLP Holdings Limited Futures Full Rate 2,100 1,680 1,680

(/lot)


(/spread)

China Merchants Bank Co. Ltd. Futures Full Rate 474 379 379

(/lot)


(/spread)

CNOOC Limited Futures Full Rate 933 746 746

(/lot)


(/spread)

Cathay Pacific Airways Limited Futures Full Rate 933 747 747

(/lot)


(/spread)


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China Petroleum & Chemical CorporationFutures

Full Rate 938 750 750

(/lot)


(/spread)

CSOP FTSE China A50 ETF Futures Full Rate 2,960 2,370 2,370

(/lot)


(/spread)

China Telecom Corporation Ltd. Futures Full Rate 587 470 446

(/lot)


(/spread)

Esprit Holdings Limited Futures Full Rate 79 63 63

(/lot)


(/spread)

FIH Mobile Limited Futures Full Rate 362 290 272

(/lot)


(/spread)

Power Assets Holdings Limited Futures Full Rate 2,310 1,850 1,850

(/lot)


(/spread)

Hong Kong Exchanges and Clearing Limited

Futures

Full Rate 1,150 913 913

(/lot)


(/spread)

HSBC Holdings Plc. Futures Full Rate 2,070 1,650 1,650

(/lot)


(/spread)

The Hong Kong and China Gas CompanyLimited Futures (HKG - Multiplier = 1,000)

Full Rate 1,130 904 904

(/lot)


(/spread)

The Hong Kong and China Gas CompanyLimited Futures (HKE - Multiplier = 1,100)

Full Rate 1,243 994 994

(/lot)


(/spread)

Henderson Land Development CompanyLimited Futures (HLD - Multiplier = 1,000)

Full Rate 3,380 2,710 2,580

(/lot)


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(/spread)

Henderson Land Development CompanyLimited Futures (HLB - Multiplier = 1,100)

Full Rate 3,718 2,981 2,838

(/lot)


(/spread)

Huaneng Power International, Inc. Futures Full Rate 1,350 1,080 1,010

(/lot)


(/spread)

Hang Seng Bank Limited Futures Full Rate 828 662 662

(/lot)


(/spread)

Hutchison Whampoa Limited Futures (HWL -

Multiplier = 1,000)

Full Rate 6,520 5,220 5,220

(/lot)

Spread Rate 1,960 1,570 1,570

(/spread)

Hutchison Whampoa Limited Futures (HWA -Multiplier = 1,069)

Full Rate 6,972 5,582 5,582

(/lot)

Spread Rate 2,096 1,679 1,679

(/spread)

Industrial and Commercial Bank of China Ltd.Futures

Full Rate 325 260 260

(/lot)


(/spread)

Li & Fung Limited Futures (LIF - Multiplier =2,000)

Full Rate 1,290 1,030 1,030

(/lot)


(/spread)

Li & Fung Limited Futures (LIB - Multiplier =2,392)

Full Rate 1,543 1,232 1,232

(/lot)


(/spread)

MTR Corporation Limited Futures Full Rate 973 778 778

(/lot)


(/spread)

New World Development Co. Ltd. Futures(NWD - Multiplier = 1,000)

Full Rate 617 493 493

(/lot)


(/spread)


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New World Development Co. Ltd. Futures(NWA - Multiplier = 1,062)

Full Rate 655 524 524

(/lot)


(/spread)

Ping An Insurance (Group) Co. of China Ltd.

Futures

Full Rate 2,010 1,610 1,610

(/lot)


(/spread)

PetroChina Company Limited Futures Full Rate 1,330 1,070 1,070

(/lot)


(/spread)

PICC Property and Casualty Co. LimitedFutures

Full Rate 1,640 1,310 1,240

(/lot)


(/spread)

Sun Hung Kai Properties Limited Futures(SHKMultiplier = 1,000)

Full Rate 7,290 5,840 5,840

(/lot)

Spread Rate 2,190 1,760 1,760

(/spread)

Sun Hung Kai Properties Limited Futures(SKAMultiplier = 1,007)

Full Rate 7,338 5,878 5,878

(/lot)

Spread Rate 2,204 1,772 1,772

(/spread)

Swire Pacific Limited "A" Shares Futures Full Rate 3,240 2,590 2,590

(/lot)


(/spread)

The Wharf (Holdings) Ltd. Futures Full Rate 3,860 3,090 3,050

(/lot)


(/spread)

Documents

Assignment 2 Chapter 8