Futures, Forwards and Swaps

Key Concepts and Skills

 Understand

the basics of forward and futures contracts  Understand how derivatives can be used to hedge risks faced by the corporation

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Chapter Outline

25.1 Derivatives, Hedging, and Risk 25.2 Forward Contracts 25.3 Futures Contracts 25.4 Hedging 25.5 Interest Rate Futures Contracts 25.6 Duration Hedging 25.7 Swap Contracts 25.8 Actual Use of Derivatives

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25.2 Forward Contracts

A

forward contract specifies that a certain commodity will be exchanged at a specified time in the future at a price specified today.

Its not an option: both parties are expected to hold up their end of the deal.  If you have ever ordered a textbook that was not in stock, you have entered into a forward contract.



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25.3 Futures Contracts

A



futures contract is like a forward contract:

It specifies that a certain commodity will be exchanged at a specified time in the future at a price specified today.

A



futures contract is different from a forward:

Futures are standardized contracts trading on organized exchanges with daily resettlement (“marking to market”) through a clearinghouse.

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Futures Contracts

 Standardizing

 Contract

Features

Size  Delivery Month

 Daily

resettlement

the chance of default

 Minimizes

 Initial

Margin

 About

4-10% of contract value  Cash or T-bills held in a street name at your brokerage

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Daily Resettlement: An Example

Suppose you want to speculate on a rise in the $/¥ exchange rate (specifically, you think that the dollar will appreciate).

U.S. $ equivalent Wed Tue 0.007142857 0.007194245 0.006993007 0.007042254 0.006666667 0.006711409 0.00625 0.006289308 Currency per U.S. $ Wed Tue 140 139 143 142 150 149 160 159

Japan (yen) 1-month forward 3-months forward 6-months forward

Currently $1 = ¥140. The 3-month forward price is $1=¥150.

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Daily Resettlement: An Example

Currently $1 = ¥140, and it appears that the...