FINC203 Derivatives Markets: Forward and Futures Markets

Flashcards on Derivatives Markets: Forward and Futures Markets

Risk (Broad Definition)

Things don’t turn out as expected; they turn out worse.

Derivative Security

A financial instrument whose value is derived from some underlying security. Its value changes as the underlying security changes.

Forward Contract

Guarantees the delivery of an amount of goods/assets on a specific day in the future, involving two parties agreeing today on a price (the forward price).

Spot Price

The observed price today at which current transactions with delivery today (or very close to today) take place.

Long Position (Forward Contract)

The buyer of the forward contract who will gain if the spot price at settlement is above the agreed forward price.

Short Position (Forward Contract)

The seller of the forward contract who will gain if the spot price at settlement is below the agreed forward price.

Arbitrage

The simultaneous buying and selling of securities, currency, or commodities in different markets or derivative forms to profit from differing prices.

FX Forward

A contractual agreement between a client and a bank, or a non-bank provider, to exchange a pair of currencies at a set rate on a future date, minimizing currency risk.

Futures Contract

Similar to forward contracts, but trade on an organized exchange and are standardized. Parties hold contracts with the exchange or clearinghouse, not each other.

Marked to Market

Futures positions are adjusted daily to reflect profits and losses, which are settled each day.

Initial Margins

Money the buyer and seller must deposit at the clearing house to ensure they honor the futures contract.

Hedgers

Participants in futures and forward markets who engage in financial-market transactions to reduce price risk.

Speculators

Participants in futures and forward markets who assume price risk in the expectation of earning a high return.

Payoff of a Long Position (Futures/Forward Contract)

St - F, where St is the spot price at maturity and F is the futures/forward price in the contract.

Payoff of a Short Position (Futures/Forward Contract)

F - St, where St is the spot price at maturity and F is the futures/forward price in the contract.

Deliverable Contracts

Settled by physical delivery of the asset.

Non-Deliverable Contracts

Settled by money (cash settlement price).