Description
This is a doc includes topics like options,futures and derivatives.
Speculation in the Financial Futures Market
Options, Futures and Derivatives
1. Key Factors which drive Future’s prices. The following are the key factors which affect the future’s prices thus differentiating between contango and backwardation 1. 2. 3. 4. 5. Type of the underlying asset in terms of the convenience of storage Liquidity in the future’s market. Interest rate variations Spot price of the underlying asset Supply and demand for the future’s contract.
2. How would a hedger use futures markets Hedgers buy or sell futures contracts with a motive of offsetting their risk. Hedgers usually take a position in the futures market opposite to that of one already held in the spot market. They also insure themselves against adverse price fluctuations of the underlying asset. Unlike speculators, hedgers actually deal in the financial instruments (underlying asset) specified in the futures contract. 3. How does a speculator use futures markets? Illustrate the risks and rewards available in the futures market, using the examples in the case. Speculators buy or sell futures contracts with a motive of making profits from the price fluctuations. They assume the risk of price fluctuations in an attempt to earn a return. Unlike hedgers, Speculators do not deal in the financial instruments (underlying asset). Speculators intend to gain from the leverage available in the futures contracts. This is because the initial margin is only a fraction of the contact value. As given in the case, John Park intends to make money by buying a huge volume of bund futures with a hope that the spurious increase in demand would result in a price hike. He would then sell the bund futures at that price in result making a huge profit. The risks involved are that he was trading with margin money of £1 million and an exposure of £1 billion. If his intention of manipulating the market was known to any large trader, they could trade against him and wipe him out. 4. How could John Park have made serious money? With margin money of £1 million John Park could have taken a long position in the bund market within his limits. Since the liquidity in the bund market was very low due to Christmas the prices of bund futures were very low. Post Christmas and new year when trading resumes in full swing the liquidity would increase and prices of bund futures would rise. At this time Park can take a reverse position and thereby make good profits. 5. Role of Margin calls in short and long positions. Margin calls: If the balance in the margin account falls below the maintenance margin the trader or investor receives a margin call. The trader is expected to top up the margin account to the initial margin level. In a short position if the future prices increase more than the price at which the contract was formulated and vice versa in a long position, the net loss is
deducted from the margin and in case the margin goes below the maintenance margin the broker calls the investor asking him to top up the margin. 6. Update the case using Euro futures instead of Bund futures The trading volume was thin as dealers were waiting for introduction of Euro. If Park had held his bund positions till the introduction of Euro then the bund prices would have been quoted in Euros. As Euro was a currency for the entire European Union, the Euro future prices might have gone up.
doc_749377006.docx
This is a doc includes topics like options,futures and derivatives.
Speculation in the Financial Futures Market
Options, Futures and Derivatives
1. Key Factors which drive Future’s prices. The following are the key factors which affect the future’s prices thus differentiating between contango and backwardation 1. 2. 3. 4. 5. Type of the underlying asset in terms of the convenience of storage Liquidity in the future’s market. Interest rate variations Spot price of the underlying asset Supply and demand for the future’s contract.
2. How would a hedger use futures markets Hedgers buy or sell futures contracts with a motive of offsetting their risk. Hedgers usually take a position in the futures market opposite to that of one already held in the spot market. They also insure themselves against adverse price fluctuations of the underlying asset. Unlike speculators, hedgers actually deal in the financial instruments (underlying asset) specified in the futures contract. 3. How does a speculator use futures markets? Illustrate the risks and rewards available in the futures market, using the examples in the case. Speculators buy or sell futures contracts with a motive of making profits from the price fluctuations. They assume the risk of price fluctuations in an attempt to earn a return. Unlike hedgers, Speculators do not deal in the financial instruments (underlying asset). Speculators intend to gain from the leverage available in the futures contracts. This is because the initial margin is only a fraction of the contact value. As given in the case, John Park intends to make money by buying a huge volume of bund futures with a hope that the spurious increase in demand would result in a price hike. He would then sell the bund futures at that price in result making a huge profit. The risks involved are that he was trading with margin money of £1 million and an exposure of £1 billion. If his intention of manipulating the market was known to any large trader, they could trade against him and wipe him out. 4. How could John Park have made serious money? With margin money of £1 million John Park could have taken a long position in the bund market within his limits. Since the liquidity in the bund market was very low due to Christmas the prices of bund futures were very low. Post Christmas and new year when trading resumes in full swing the liquidity would increase and prices of bund futures would rise. At this time Park can take a reverse position and thereby make good profits. 5. Role of Margin calls in short and long positions. Margin calls: If the balance in the margin account falls below the maintenance margin the trader or investor receives a margin call. The trader is expected to top up the margin account to the initial margin level. In a short position if the future prices increase more than the price at which the contract was formulated and vice versa in a long position, the net loss is
deducted from the margin and in case the margin goes below the maintenance margin the broker calls the investor asking him to top up the margin. 6. Update the case using Euro futures instead of Bund futures The trading volume was thin as dealers were waiting for introduction of Euro. If Park had held his bund positions till the introduction of Euro then the bund prices would have been quoted in Euros. As Euro was a currency for the entire European Union, the Euro future prices might have gone up.
doc_749377006.docx