Financial Derivatives: How Cme Works

MBA 6209 Financial Derivatives

(Yoshi)

HOMEWORK ASSIGNMENT ON VIDEO 1: UNDERSTANDING THE DERIVATIVES CLEARING PROCESS

1. Explain the meaning of clearing and the cash flows that happens in a stock vs a futures transaction.

The meaning of clearing for stocks is exchange of the cash for the underlying security. And it takes couples days to settle the transaction matched and to finish the process.

Main difference of the transaction between a stock and a future is the life of the position that future trade can exist or expire. And risk management process and marked to market process happen every day over the period of time for futures transaction.

2. Explain the difference between margin in stock transaction vs futures transaction?

Margins for stock transaction and future transaction are very different. The function of future transaction’s margin is performance bond, prepayment of anticipated losses, which is similar to deposit to pay to the land owner. On the contrary, securities margin is like down-payment of a house, to borrow money up front.

3. How does the CME determine the margin requirement?

The amount of money is based on risk. If the price of the product moves frequently, the margin would be higher. For example, the margin for the contract of S&P 500 tend be $15,000 to $20,000, and the margin for the contract of Euro dollar $500 to $800. And this is based on marked-to-market process of every day, so the margin continues to be reset every day as well.

4. Explain the role and functions of a clearing house and describe the transactions that take place.

CME enters the transaction when the trade is submitted for clearing. The function is legal action to each buyer and seller, to become seller to the buyer and buyer to the seller. Other than risk management and marked-to-market process, clearing house does 24 hour risk management to clearing house members’ profile of profit and loss.

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