8 - Principles of Forwards and Futures Flashcards

1
Q

what are five key features of the forwards contract?

A
  • contract between two private parties
  • non-standard contract
  • usually one specific delivery date
  • settled at maturity
  • delivery of final cash settlement usually occurs
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2
Q

what are five key features of the futures contract?

A
  • exchange traded
  • standard contract
  • range of delivery dates
  • settled daily
  • contract usually closed prior to maturity
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3
Q

what are characteristics of the futures price when compared to spot price?

A

can be above or below the spot price, at maturity they equal the spot price

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4
Q

if the market is efficient what can usually be said about equity instrument prices? what can be said about a forward and futures prices?

A

“price = value

price = contracted rates of future purchase
therefore price is not = to value”

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5
Q

what is the value of a futures or forwards contract at the beginning?

A

value = 0

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6
Q

what is the value/price notation for forwards and for futures?

A
  • forward: Vt(0,T), Ft(0,T)

- where 0 is time contract is created and T is time contract expires future: vt(T), ft(T).

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7
Q

what is the forwards price at expiration worth?

A

F(T,T) = St

meaning the price of a forward contract is equal to the spot price at expiration

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8
Q

what does cost of carry consist of? how is it denoted

A

“cost of storing asset, plus interest forgone for the period that the asset is held

theta”

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9
Q

on the day before expiry, what is the price of a futures contract equal to? f(T) = 0

A

futures contract is equal to forwards contract the day before expiry

f(T) = f(t,T)

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10
Q

which three factors have the effect of decreasing the initial value of the spot price one is willing to pay for a futures contract?

A
  • volatility: not being able to estimate what the value will be as expiration i.e. St becomes E(St)
  • cost of carry (-s)
  • loss of interest on money invested in contract i.e. -Soi
  • risk aversion: investors require a risk premium to invest in the contract

So = E(St) - s - Soi - risk premium

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11
Q

what does contango and backwardation mean?

A
contango= when f(T) > So usually in stable markets
backwardation= when f(T) < So
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12
Q

what is normal contango/backwardation? what does it imply?

A
  • Nor Con - f(T) > Expected (St)
  • Nor Bac - f(T) < Expected (St)

market consists of speculators

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13
Q

what effects do dividends have on cost of carry?

A

they reduce the cost of carry

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14
Q

what is the spread of two futures contracts with T1 and T2 to expiry?

A

the difference in the cost of carry between the two

i.e. theta 2 - theta 1

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