1 Chapter 13 Financial Futures Markets Financial Markets and Institutions, 7e, Jeff Madura Copyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved. 2 Chapter Outline Background on financial futures Interpreting financial futures tables Valuation of financial futures Explaining price movements of bond futures contracts Speculating with interest rate futures Closing out the futures position 3 Chapter Outline (cont’d) Hedging with interest rate futures Bond index futures Stock index futures Single stock futures Risk of trading futures contracts Regulation in the futures markets Institutional use of futures markets Globalization of futures markets 4 Background on Financial Futures A financial futures contract is a standardized agreement to deliver or receive a specified amount of a specified financial instrument at a specified price and date The buyer of a futures buys the instrument while the seller delivers the instrument Futures are traded on organized exchanges The exchanges clear, settle, and guarantee all transactions that occur on the exchange Futures are regulated by the Commodity Futures Trading Commissions (CFTC) Approves futures contracts and imposes regulations 5 Background on Financial Futures (cont’d) Interest rate futures are on debt securities such as T-bills, T-notes, T-bonds, and Eurodollar CDs Stock index futures are on stock indexes Settlement dates are in March, June, September, and December Most financial futures are traded on the Chicago Board of Trade or the Chicago Mercantile Exchange 6 Background on Financial Futures (cont’d) Purpose of trading financial futures Traded either to speculate on prices of securities or to hedge existing exposure to security price movements Speculators take positions to profit from expected changes in the price of futures contracts over time Day traders attempt to capitalize on price movements during a single day Position traders maintain their futures positions for longer periods of time Hedgers take positions to reduce their exposure to future movements in interest rates or stock prices 7 Background on Financial Futures (cont’d) Electronic trading The Chicago Mercantile Exchange established GLOBEX that compliments its floor trading Allows for around the clock and weekend trading The Chicago Board Options Exchange implemented a fully electronic futures exchange in 2004 8 Background on Financial Futures (cont’d) Steps involved in trading futures Members of a futures exchange are either: Commission brokers, who execute orders for their customers and are often employed by brokerage firms Floor traders (locals), who trade futures contracts for their own account Many types of futures contracts now trade over the counter Are more personalized and can be tailored to the specific preferences of the parties involved 9 Background on Financial Futures (cont’d) Steps involved in trading futures (cont’d) Customers must establish margin deposits with their brokers Initial margin is typically between 5 and 18 percent of a futures’ full value A futures contract price is “marked to market” daily Customers may receive a margin call if the value moves in an unfavorable direction A market order is executed at the prevailing price of the futures contract A limit order is executed only if the price is within the limit specified 10 Background on Financial Futures (cont’d) Steps involved in trading futures (cont’d) How orders are executed Brokerage firms communicate customers’ order to telephone stations located near the trading floor Floor brokers accommodate orders When two traders on the floor reach an agreement through open outcry, the information is transmitted to the customers Floor brokers receive transaction fees in the form of a bid- ask spread The futures exchange acts as a clearinghouse [...]... Impact of the opportunity cost Investors who buy stock index futures instead of the stock index do not receive any dividends Investors who buy stock index futures put up a much smaller investment 13 Explaining Price Movements of Bond Futures Contracts Participants in the Treasury bond futures market closely monitor the same economic indicators monitored by participants in the Treasury bond market: . 1 Chapter 13 Financial Futures Markets Financial Markets and Institutions, 7e, Jeff. ©2006 by South-Western, a division of Thomson Learning. All rights reserved. 2 Chapter Outline Background on financial futures Interpreting financial futures