Podcast
Questions and Answers
Which of the following statements best describes a key difference between futures and forward contracts?
Which of the following statements best describes a key difference between futures and forward contracts?
- Futures contracts are standardized and exchange-traded, while forward contracts are traded over-the-counter and can be customized. (correct)
- Futures contracts involve immediate delivery of the asset, while forward contracts specify a future delivery date.
- Futures contracts are traded over-the-counter, allowing for customization, while forward contracts are standardized and exchange-traded.
- Futures contracts are regulated by government agencies, while forward contracts are unregulated.
What role do exchanges like the CME Group play in the futures market?
What role do exchanges like the CME Group play in the futures market?
- They regulate the over-the-counter market for forward contracts.
- They standardize contract terms and provide a platform for trading futures contracts. (correct)
- They set the prices for all futures contracts based on supply and demand.
- They act as counterparties to all futures contracts, bearing the credit risk.
A trader instructs a broker to 'take a long position' in a futures contract. What does this mean?
A trader instructs a broker to 'take a long position' in a futures contract. What does this mean?
- The trader is obligated to sell the asset at the specified future date.
- The trader is buying the contract, anticipating the asset's price will increase. (correct)
- The trader is speculating that the price of the asset will decrease.
- The trader is betting on high volatility in the market.
In the context of futures trading, what is the primary function of margin accounts?
In the context of futures trading, what is the primary function of margin accounts?
How has the introduction of electronic trading impacted the price discovery process in futures markets?
How has the introduction of electronic trading impacted the price discovery process in futures markets?
What is the role of standardization in futures contracts?
What is the role of standardization in futures contracts?
Which of the following best describes the open outcry system in futures trading?
Which of the following best describes the open outcry system in futures trading?
A trader in Kansas instructs a broker to 'take a short position'. Which of the following scenarios explains why a trader might do this?
A trader in Kansas instructs a broker to 'take a short position'. Which of the following scenarios explains why a trader might do this?
Why is the contract size an important consideration for an exchange when designing a futures contract?
Why is the contract size an important consideration for an exchange when designing a futures contract?
How do exchanges handle situations where alternative delivery locations are specified in a commodity futures contract?
How do exchanges handle situations where alternative delivery locations are specified in a commodity futures contract?
What is the purpose of specifying delivery months in a futures contract?
What is the purpose of specifying delivery months in a futures contract?
How are Treasury bond and Treasury note futures prices typically quoted?
How are Treasury bond and Treasury note futures prices typically quoted?
What is the primary function of daily price limits in futures contracts?
What is the primary function of daily price limits in futures contracts?
What action might traders take if the futures price is above the spot price during the delivery period?
What action might traders take if the futures price is above the spot price during the delivery period?
What is the implication if the futures price is below the spot price during the delivery period?
What is the implication if the futures price is below the spot price during the delivery period?
What is the role of position limits in the futures market?
What is the role of position limits in the futures market?
Why does the futures price converge to the spot price as the delivery period approaches?
Why does the futures price converge to the spot price as the delivery period approaches?
What is a 'limit move' in the context of futures trading?
What is a 'limit move' in the context of futures trading?
In futures markets, what does 'delivery arrangements' primarily define?
In futures markets, what does 'delivery arrangements' primarily define?
If a futures contract is 'limit down', what typically happens?
If a futures contract is 'limit down', what typically happens?
What distinguishes the CME Group's Mini Nasdaq 100 contract from the regular Nasdaq 100 contract?
What distinguishes the CME Group's Mini Nasdaq 100 contract from the regular Nasdaq 100 contract?
Which consideration is most crucial when determining the delivery location for a commodity such as frozen concentrated orange juice?
Which consideration is most crucial when determining the delivery location for a commodity such as frozen concentrated orange juice?
What is the underlying asset for the Treasury bond futures contract traded on the Chicago Board of Trade?
What is the underlying asset for the Treasury bond futures contract traded on the Chicago Board of Trade?
How does the futures price generally behave in relation to the spot price as the delivery period approaches?
How does the futures price generally behave in relation to the spot price as the delivery period approaches?
What is the primary role of an exchange in futures trading?
What is the primary role of an exchange in futures trading?
What is 'marking to market' in the context of futures contracts?
What is 'marking to market' in the context of futures contracts?
An investor buys a futures contract. If the futures price decreases, how is their margin account affected?
An investor buys a futures contract. If the futures price decreases, how is their margin account affected?
What is the purpose of the initial margin in a futures contract?
What is the purpose of the initial margin in a futures contract?
What happens when the balance in a margin account falls below the maintenance margin?
What happens when the balance in a margin account falls below the maintenance margin?
What is a variation margin in futures trading?
What is a variation margin in futures trading?
An investor receives a margin call but fails to deposit the required funds. What is the likely outcome?
An investor receives a margin call but fails to deposit the required funds. What is the likely outcome?
What is the immediate consequence of daily settlement for an investor with a short position when the futures price decreases?
What is the immediate consequence of daily settlement for an investor with a short position when the futures price decreases?
An investor holds a long position in two gold futures contracts. The contract size is 100 ounces, and the initial futures price is $1,450 per ounce. If the futures price drops to $1,441 per ounce by the end of the day, what is the investor's loss?
An investor holds a long position in two gold futures contracts. The contract size is 100 ounces, and the initial futures price is $1,450 per ounce. If the futures price drops to $1,441 per ounce by the end of the day, what is the investor's loss?
Suppose an investor has an initial margin of $6,000 per futures contract and a maintenance margin of $4,500 per contract. If the balance in their margin account drops to $4,000 per contract, how much variation margin will they receive a call for?
Suppose an investor has an initial margin of $6,000 per futures contract and a maintenance margin of $4,500 per contract. If the balance in their margin account drops to $4,000 per contract, how much variation margin will they receive a call for?
An investor has a long position in a futures contract. On Day 1, the settlement price is $1,441.00. On Day 2, the settlement price is $1,438.30. If the contract covers 100 ounces, what is the daily gain/loss to the margin account on Day 2?
An investor has a long position in a futures contract. On Day 1, the settlement price is $1,441.00. On Day 2, the settlement price is $1,438.30. If the contract covers 100 ounces, what is the daily gain/loss to the margin account on Day 2?
Suppose an investor initially deposits $12,000 into a margin account for two futures contracts. If the cumulative gain after several days is $4,380, what is the margin account balance?
Suppose an investor initially deposits $12,000 into a margin account for two futures contracts. If the cumulative gain after several days is $4,380, what is the margin account balance?
On Day 7, an investor's margin account balance is $7,980, and the maintenance margin is $9,000. What action will the broker take?
On Day 7, an investor's margin account balance is $7,980, and the maintenance margin is $9,000. What action will the broker take?
An investor with a short position benefits when the
An investor with a short position benefits when the
An investor closes out a futures position with a cumulative loss of $4,620. On which days did the investor have excess margin, assuming it was not withdrawn?
An investor closes out a futures position with a cumulative loss of $4,620. On which days did the investor have excess margin, assuming it was not withdrawn?
Why might a broker pay interest on the balance in a margin account?
Why might a broker pay interest on the balance in a margin account?
What percentage of their face value are Treasury bills usually accepted in lieu of cash to satisfy initial margin requirements?
What percentage of their face value are Treasury bills usually accepted in lieu of cash to satisfy initial margin requirements?
How are gains or losses on a futures contract handled at the end of each day?
How are gains or losses on a futures contract handled at the end of each day?
Why do individual brokers sometimes require greater margins than the minimum levels specified by the exchange clearing house?
Why do individual brokers sometimes require greater margins than the minimum levels specified by the exchange clearing house?
How does the variability of the price of the underlying asset affect margin levels?
How does the variability of the price of the underlying asset affect margin levels?
Why are bona fide hedgers often subject to lower margin requirements than speculators?
Why are bona fide hedgers often subject to lower margin requirements than speculators?
What is a spread transaction in futures trading?
What is a spread transaction in futures trading?
How do margin requirements differ between long and short futures positions?
How do margin requirements differ between long and short futures positions?
What is the primary role of a clearing house in futures transactions?
What is the primary role of a clearing house in futures transactions?
How does a clearing house member handle transactions daily regarding gains or losses?
How does a clearing house member handle transactions daily regarding gains or losses?
How is initial margin determined by the clearing house when a member has both long and short positions?
How is initial margin determined by the clearing house when a member has both long and short positions?
What is the purpose of the guaranty fund maintained by clearing house members?
What is the purpose of the guaranty fund maintained by clearing house members?
What was a key outcome of the market crash on October 19, 1987, regarding the futures markets?
What was a key outcome of the market crash on October 19, 1987, regarding the futures markets?
What is a primary characteristic of over-the-counter (OTC) derivatives markets?
What is a primary characteristic of over-the-counter (OTC) derivatives markets?
When Company A defaults and the net value of outstanding derivative transactions with Company B is positive, which party is most likely to incur a loss?
When Company A defaults and the net value of outstanding derivative transactions with Company B is positive, which party is most likely to incur a loss?
What is the primary role of a Central Counterparty (CCP) in OTC derivative transactions?
What is the primary role of a Central Counterparty (CCP) in OTC derivative transactions?
What are the two primary forms of margin that members of a CCP are typically required to provide?
What are the two primary forms of margin that members of a CCP are typically required to provide?
If an OTC market participant is not a member of a CCP, how can it clear its trades through a CCP?
If an OTC market participant is not a member of a CCP, how can it clear its trades through a CCP?
What is one of the main drivers behind regulators pushing for more OTC transactions to be handled by CCPs?
What is one of the main drivers behind regulators pushing for more OTC transactions to be handled by CCPs?
In bilaterally cleared OTC markets, what is the purpose of a Credit Support Annex (CSA)?
In bilaterally cleared OTC markets, what is the purpose of a Credit Support Annex (CSA)?
In a simple two-way collateral agreement within a CSA, if the value of transactions between Company A and Company B increases to Company A's benefit by $X$, which action is typically required?
In a simple two-way collateral agreement within a CSA, if the value of transactions between Company A and Company B increases to Company A's benefit by $X$, which action is typically required?
What is 'convergence arbitrage,' as employed by Long-Term Capital Management (LTCM)?
What is 'convergence arbitrage,' as employed by Long-Term Capital Management (LTCM)?
What triggered the significant losses experienced by Long-Term Capital Management (LTCM) in 1998?
What triggered the significant losses experienced by Long-Term Capital Management (LTCM) in 1998?
How did Long-Term Capital Management (LTCM) expect collateral requirements to behave under normal circumstances?
How did Long-Term Capital Management (LTCM) expect collateral requirements to behave under normal circumstances?
In the context of OTC derivatives, what does 'systemic risk' refer to?
In the context of OTC derivatives, what does 'systemic risk' refer to?
Which of the following best describes the relationship between a broker and a futures exchange clearing house member, as it relates to OTC clearing?
Which of the following best describes the relationship between a broker and a futures exchange clearing house member, as it relates to OTC clearing?
How did the Russia's default on its debt in 1998 affect Long-Term Capital Management's (LTCM) positions?
How did the Russia's default on its debt in 1998 affect Long-Term Capital Management's (LTCM) positions?
If Company A agrees to purchase a commodity from Company B in one year at a set price, and this transaction clears through a CCP, what commitment does the CCP make?
If Company A agrees to purchase a commodity from Company B in one year at a set price, and this transaction clears through a CCP, what commitment does the CCP make?
Why was Long-Term Capital Management (LTCM) required to post collateral on bonds they had both bought and shorted?
Why was Long-Term Capital Management (LTCM) required to post collateral on bonds they had both bought and shorted?
What is the primary purpose of initial margin in bilaterally cleared transactions, as mandated by the 2012 regulations?
What is the primary purpose of initial margin in bilaterally cleared transactions, as mandated by the 2012 regulations?
How does bilateral clearing differ from central clearing in OTC markets, considering the number of agreements between participants?
How does bilateral clearing differ from central clearing in OTC markets, considering the number of agreements between participants?
In the context of futures and OTC markets, what is a key difference in how variation margin is treated regarding interest?
In the context of futures and OTC markets, what is a key difference in how variation margin is treated regarding interest?
What is a 'haircut' in the context of margin requirements, and what purpose does it serve?
What is a 'haircut' in the context of margin requirements, and what purpose does it serve?
Based on the futures quotes provided, if an investor believes the price of Crude Oil for December 2014 will increase, which action would directly reflect that belief?
Based on the futures quotes provided, if an investor believes the price of Crude Oil for December 2014 will increase, which action would directly reflect that belief?
According to the information provided, what was a key risk associated with Long-Term Capital Management's (LTCM) use of collateral agreements?
According to the information provided, what was a key risk associated with Long-Term Capital Management's (LTCM) use of collateral agreements?
Why are some foreign exchange transactions exempt from the 2012 regulations regarding initial and variation margin?
Why are some foreign exchange transactions exempt from the 2012 regulations regarding initial and variation margin?
Which of the following best describes the role of a Central Counterparty (CCP) in OTC markets?
Which of the following best describes the role of a Central Counterparty (CCP) in OTC markets?
Referring to the futures quotes table, what does the 'Change' column represent?
Referring to the futures quotes table, what does the 'Change' column represent?
If a clearing house member provides variation margin in the form of securities, how is the value of these securities determined for margin purposes?
If a clearing house member provides variation margin in the form of securities, how is the value of these securities determined for margin purposes?
What does the term 'prior settlement' refer to in the context of futures contracts, as shown in the provided quotes?
What does the term 'prior settlement' refer to in the context of futures contracts, as shown in the provided quotes?
Based on the provided text, what is the contract size for Gold futures?
Based on the provided text, what is the contract size for Gold futures?
What does the 'volume' column in Table 2.2 indicate regarding futures contracts?
What does the 'volume' column in Table 2.2 indicate regarding futures contracts?
Considering the context of initial margins, what happens to the initial margin typically provided for bilaterally cleared transactions between financial institutions?
Considering the context of initial margins, what happens to the initial margin typically provided for bilaterally cleared transactions between financial institutions?
How might the effectiveness of CCPs in reducing credit risk be influenced by the number of CCPs operating in the market and the proportion of trades they clear?
How might the effectiveness of CCPs in reducing credit risk be influenced by the number of CCPs operating in the market and the proportion of trades they clear?
What does the 'settlement price' in futures trading primarily determine?
What does the 'settlement price' in futures trading primarily determine?
If a trader holds a short position in a futures contract and the settlement price increases, what is the immediate impact on their margin account, assuming all other factors remain constant?
If a trader holds a short position in a futures contract and the settlement price increases, what is the immediate impact on their margin account, assuming all other factors remain constant?
In a futures market context, what does 'open interest' signify?
In a futures market context, what does 'open interest' signify?
What characterizes a 'normal market' in the context of futures prices?
What characterizes a 'normal market' in the context of futures prices?
What is an 'inverted market' (or backwardation) in futures trading?
What is an 'inverted market' (or backwardation) in futures trading?
In futures trading, who has the responsibility of deciding when to make delivery of the underlying asset, assuming the contract is not closed out early?
In futures trading, who has the responsibility of deciding when to make delivery of the underlying asset, assuming the contract is not closed out early?
What information is typically included in the 'notice of intention to deliver' issued by a seller in a futures contract?
What information is typically included in the 'notice of intention to deliver' issued by a seller in a futures contract?
When a notice of intention to deliver is issued, which party is generally selected by the exchange to accept the delivery?
When a notice of intention to deliver is issued, which party is generally selected by the exchange to accept the delivery?
In the context of commodity futures, what does taking delivery generally entail?
In the context of commodity futures, what does taking delivery generally entail?
For financial futures, such as those based on stock indices or interest rates, how is delivery typically made?
For financial futures, such as those based on stock indices or interest rates, how is delivery typically made?
What is the 'first notice day' in the context of a futures contract?
What is the 'first notice day' in the context of a futures contract?
Which of the following statements accurately describes the relationship between the 'last trading day' and the 'last notice day' for a futures contract?
Which of the following statements accurately describes the relationship between the 'last trading day' and the 'last notice day' for a futures contract?
If a trader with a long position receives a notice of intention to deliver but prefers not to take delivery, what action can they take, assuming the notices are transferable?
If a trader with a long position receives a notice of intention to deliver but prefers not to take delivery, what action can they take, assuming the notices are transferable?
What is the primary reason understanding delivery procedures is important in futures trading, even though most contracts are closed out before delivery?
What is the primary reason understanding delivery procedures is important in futures trading, even though most contracts are closed out before delivery?
Suppose a gold futures contract specifies delivery in a particular location and grade. If the exchange adjusts the settlement price based on an alternative delivery location or grade, what is the purpose of this adjustment?
Suppose a gold futures contract specifies delivery in a particular location and grade. If the exchange adjusts the settlement price based on an alternative delivery location or grade, what is the purpose of this adjustment?
What is the primary objective of the National Futures Association (NFA)?
What is the primary objective of the National Futures Association (NFA)?
What action might regulators take when an investor group attempts to 'corner the market'?
What action might regulators take when an investor group attempts to 'corner the market'?
What is 'front running' in the context of futures trading irregularities?
What is 'front running' in the context of futures trading irregularities?
Under what conditions can a company apply hedge accounting to a futures contract?
Under what conditions can a company apply hedge accounting to a futures contract?
How does hedge accounting affect the timing of recognizing gains or losses from a futures contract?
How does hedge accounting affect the timing of recognizing gains or losses from a futures contract?
According to FAS 133, how are derivative instruments like futures contracts reported on a company's balance sheet?
According to FAS 133, how are derivative instruments like futures contracts reported on a company's balance sheet?
What is a key requirement for using hedge accounting under FAS 133?
What is a key requirement for using hedge accounting under FAS 133?
How are capital losses treated for corporate taxpayers under US tax rules?
How are capital losses treated for corporate taxpayers under US tax rules?
Which event led to an expansion of the CFTC's responsibilities, particularly in regulating over-the-counter derivatives?
Which event led to an expansion of the CFTC's responsibilities, particularly in regulating over-the-counter derivatives?
A company hedges the purchase of a commodity using futures contracts. If the futures prices increase, what is the likely impact on the effective price the company pays for the commodity?
A company hedges the purchase of a commodity using futures contracts. If the futures prices increase, what is the likely impact on the effective price the company pays for the commodity?
How does the accounting treatment differ for a futures contract that qualifies as a hedge versus one that does not?
How does the accounting treatment differ for a futures contract that qualifies as a hedge versus one that does not?
What is the potential consequence for a trader who overcharges customers or fails to pay them the full proceeds of sales in futures trading?
What is the potential consequence for a trader who overcharges customers or fails to pay them the full proceeds of sales in futures trading?
Why might trading irregularities, such as attempts to 'corner the market', lead to regulatory intervention?
Why might trading irregularities, such as attempts to 'corner the market', lead to regulatory intervention?
In the context of tax treatment for futures contracts, what is the significance of classifying gains or losses as either capital or ordinary?
In the context of tax treatment for futures contracts, what is the significance of classifying gains or losses as either capital or ordinary?
Under FAS 133, what assessment is required every three months to use hedge accounting?
Under FAS 133, what assessment is required every three months to use hedge accounting?
How are gains or losses from hedging transactions treated for tax purposes, and what condition must be met?
How are gains or losses from hedging transactions treated for tax purposes, and what condition must be met?
For a noncorporate taxpayer, how are capital losses treated for tax purposes?
For a noncorporate taxpayer, how are capital losses treated for tax purposes?
What is a key difference in how gains or losses are realized between forward and futures contracts?
What is a key difference in how gains or losses are realized between forward and futures contracts?
Under what circumstances might a noncorporate taxpayer elect to carry back net losses from the 60/40 rule?
Under what circumstances might a noncorporate taxpayer elect to carry back net losses from the 60/40 rule?
How does the tax definition of a hedging transaction differ primarily from its accounting definition?
How does the tax definition of a hedging transaction differ primarily from its accounting definition?
What is the '60/40 rule' and how does it apply to noncorporate taxpayers?
What is the '60/40 rule' and how does it apply to noncorporate taxpayers?
Why is it important for a company to clearly identify a hedging transaction in its records?
Why is it important for a company to clearly identify a hedging transaction in its records?
Which situation would exemplify a hedging transaction as defined by tax regulations?
Which situation would exemplify a hedging transaction as defined by tax regulations?
How are foreign currency exchange rates typically quoted for futures versus forward contracts when the U.S. dollar is involved?
How are foreign currency exchange rates typically quoted for futures versus forward contracts when the U.S. dollar is involved?
What is a primary distinction regarding standardization between forward and futures contracts?
What is a primary distinction regarding standardization between forward and futures contracts?
A U.S. company anticipates receiving payment of 1,000,000 Canadian dollars (CAD) in 90 days. To hedge against a potential decline in the CAD relative to the USD, should the company take a long or short futures position in CAD?
A U.S. company anticipates receiving payment of 1,000,000 Canadian dollars (CAD) in 90 days. To hedge against a potential decline in the CAD relative to the USD, should the company take a long or short futures position in CAD?
A non-corporate taxpayer has $5,000 in capital gains and $8,000 in capital losses for the tax year. What amount of the capital losses can be deducted in the current year, and what happens to the rest?
A non-corporate taxpayer has $5,000 in capital gains and $8,000 in capital losses for the tax year. What amount of the capital losses can be deducted in the current year, and what happens to the rest?
Trader A holds a forward contract, while Trader B holds a futures contract on the same asset with the same expiration date. Both contracts are initially valued the same. If the asset's price fluctuates significantly over the contract period, which trader is more likely to experience a greater impact from the daily settlement process?
Trader A holds a forward contract, while Trader B holds a futures contract on the same asset with the same expiration date. Both contracts are initially valued the same. If the asset's price fluctuates significantly over the contract period, which trader is more likely to experience a greater impact from the daily settlement process?
A company borrows money and uses futures contracts to reduce the risk of interest rate changes related to these borrowings. According to tax regulations, under what condition can this strategy be considered a hedging transaction?
A company borrows money and uses futures contracts to reduce the risk of interest rate changes related to these borrowings. According to tax regulations, under what condition can this strategy be considered a hedging transaction?
A non-corporate taxpayer has a long-term capital gain of $10,000 and a short-term capital loss of $4,000. What is the net capital gain or loss, how is it taxed, and can any loss be carried forward?
A non-corporate taxpayer has a long-term capital gain of $10,000 and a short-term capital loss of $4,000. What is the net capital gain or loss, how is it taxed, and can any loss be carried forward?
What was the direct consequence of the new employee's error in the live cattle futures contract scenario?
What was the direct consequence of the new employee's error in the live cattle futures contract scenario?
Why did the financial institution have to delve into the specifics of the live cattle futures contract's delivery arrangements?
Why did the financial institution have to delve into the specifics of the live cattle futures contract's delivery arrangements?
In the context of futures contracts, what action constitutes 'closing out' a position?
In the context of futures contracts, what action constitutes 'closing out' a position?
Why is the possibility of final delivery important in futures contracts?
Why is the possibility of final delivery important in futures contracts?
In the context of futures contracts, what does the exchange specify when developing a new contract?
In the context of futures contracts, what does the exchange specify when developing a new contract?
When alternatives are specified for the grade of the asset or delivery locations in a futures contract, who typically makes the decision on which alternative to use?
When alternatives are specified for the grade of the asset or delivery locations in a futures contract, who typically makes the decision on which alternative to use?
What key information does a party with a short position include when filing a notice of intention to deliver with the exchange?
What key information does a party with a short position include when filing a notice of intention to deliver with the exchange?
Why is it important for an exchange to stipulate the grade or grades of a commodity that are acceptable in a futures contract?
Why is it important for an exchange to stipulate the grade or grades of a commodity that are acceptable in a futures contract?
According to the content, what is the standard grade for the CME Group's corn futures contract?
According to the content, what is the standard grade for the CME Group's corn futures contract?
In the context of futures trading, how is the price of a commodity like September corn determined, according to the text?
In the context of futures trading, how is the price of a commodity like September corn determined, according to the text?
For the CME Group's corn futures contract, what is the price adjustment for delivering No. 1 Yellow corn compared to the standard grade?
For the CME Group's corn futures contract, what is the price adjustment for delivering No. 1 Yellow corn compared to the standard grade?
What immediate action occurs if more traders wish to sell rather than buy September corn futures?
What immediate action occurs if more traders wish to sell rather than buy September corn futures?
Under the terms described, what challenge did the employee face upon receiving the live cattle?
Under the terms described, what challenge did the employee face upon receiving the live cattle?
What does the IntercontinentalExchange (ICE) specify as the asset in its orange juice futures contract?
What does the IntercontinentalExchange (ICE) specify as the asset in its orange juice futures contract?
How is a trader's total gain or loss determined when closing out a futures contract position?
How is a trader's total gain or loss determined when closing out a futures contract position?
What is the primary reason an investor with a long position might close out their futures contract before the first notice day?
What is the primary reason an investor with a long position might close out their futures contract before the first notice day?
Which of the following describes the process of cash settlement in financial futures?
Which of the following describes the process of cash settlement in financial futures?
What distinguishes futures commission merchants (FCMs) from locals in futures trading?
What distinguishes futures commission merchants (FCMs) from locals in futures trading?
How do day traders differ from position traders in the futures market?
How do day traders differ from position traders in the futures market?
Which of the following best describes a 'market order' in futures trading?
Which of the following best describes a 'market order' in futures trading?
How does a limit order protect an investor in the futures market?
How does a limit order protect an investor in the futures market?
What is the primary purpose of using a stop-loss order?
What is the primary purpose of using a stop-loss order?
How does a stop-limit order function in futures trading?
How does a stop-limit order function in futures trading?
What triggers the execution of a market-if-touched (MIT) order?
What triggers the execution of a market-if-touched (MIT) order?
What is the key characteristic of a discretionary order (market-not-held order)?
What is the key characteristic of a discretionary order (market-not-held order)?
How does a 'time-of-day' order differ from a 'day order' in futures trading?
How does a 'time-of-day' order differ from a 'day order' in futures trading?
What is the primary role of the Commodity Futures Trading Commission (CFTC)?
What is the primary role of the Commodity Futures Trading Commission (CFTC)?
Which of the following actions does the CFTC undertake to ensure the integrity of futures markets?
Which of the following actions does the CFTC undertake to ensure the integrity of futures markets?
An investor holds a short position in a futures contract. What type of order would be MOST suitable to ensure profits are taken if sufficiently favorable price movements occur?
An investor holds a short position in a futures contract. What type of order would be MOST suitable to ensure profits are taken if sufficiently favorable price movements occur?
What is the difference between 'open order' and 'fill-or-kill order'?
What is the difference between 'open order' and 'fill-or-kill order'?
Flashcards
Futures Contract
Futures Contract
An agreement to buy or sell an asset at a specified future date for a predetermined price, traded on an exchange with standardized terms.
Forward Contract
Forward Contract
An agreement to buy or sell an asset at a specified future date for a predetermined price, traded over-the-counter and can be customized.
Futures Exchange
Futures Exchange
A central location where futures contracts are traded.
CME Group
CME Group
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Long Position (Futures)
Long Position (Futures)
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Short Position (Futures)
Short Position (Futures)
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Open Outcry System
Open Outcry System
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Electronic Trading
Electronic Trading
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Spot Price
Spot Price
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Treasury Bond Futures
Treasury Bond Futures
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Treasury Note Futures
Treasury Note Futures
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Contract Size
Contract Size
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Mini Contracts
Mini Contracts
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Delivery Location
Delivery Location
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Delivery Month
Delivery Month
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Price Quote
Price Quote
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Daily Price Limits
Daily Price Limits
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Limit Down
Limit Down
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Limit Up
Limit Up
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Limit Move
Limit Move
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Position Limits
Position Limits
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Price Convergence
Price Convergence
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Arbitrage Opportunity
Arbitrage Opportunity
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Closing Out a Futures Position
Closing Out a Futures Position
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Delivery in Futures
Delivery in Futures
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Futures & Spot Price Link
Futures & Spot Price Link
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Futures Contract Specification
Futures Contract Specification
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Short Position's Choice
Short Position's Choice
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Notice of Intention to Deliver
Notice of Intention to Deliver
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Commodity Grade Specification
Commodity Grade Specification
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No. 1 Yellow Corn
No. 1 Yellow Corn
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No. 2 Yellow Corn
No. 2 Yellow Corn
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No. 3 Yellow Corn
No. 3 Yellow Corn
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Futures Trading Error
Futures Trading Error
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Live Cattle Futures
Live Cattle Futures
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Hedging
Hedging
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Closing a Short Position
Closing a Short Position
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Closing a Long Position
Closing a Long Position
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Convergence of Futures Price
Convergence of Futures Price
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Margin Account
Margin Account
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Daily Settlement (Marking to Market)
Daily Settlement (Marking to Market)
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Initial Margin
Initial Margin
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Maintenance Margin
Maintenance Margin
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Margin Call
Margin Call
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Variation Margin
Variation Margin
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Closing Out a Position
Closing Out a Position
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Decrease in Futures Price (Long Position)
Decrease in Futures Price (Long Position)
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Increase in Futures Price (Short positions)
Increase in Futures Price (Short positions)
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Margin Account Safety
Margin Account Safety
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Margin Withdrawal
Margin Withdrawal
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Trade Settlement
Trade Settlement
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Exchange key roles
Exchange key roles
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Interest on Margin Balance
Interest on Margin Balance
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Securities in Lieu of Cash
Securities in Lieu of Cash
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Daily Settlement
Daily Settlement
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Minimum Margin Levels
Minimum Margin Levels
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Day Trade
Day Trade
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Spread Transaction
Spread Transaction
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Clearing House
Clearing House
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Clearing Margin
Clearing Margin
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Guaranty Fund
Guaranty Fund
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Credit Risk
Credit Risk
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OTC Markets
OTC Markets
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Central Counterparty (CCP)
Central Counterparty (CCP)
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CCP Member Requirements
CCP Member Requirements
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CCP's Role
CCP's Role
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Bilateral Clearing
Bilateral Clearing
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Credit Support Annex (CSA)
Credit Support Annex (CSA)
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Collateral in CSAs
Collateral in CSAs
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Daily Valuation
Daily Valuation
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Two-Way Collateral Agreement
Two-Way Collateral Agreement
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Variation Margin (OTC)
Variation Margin (OTC)
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Systemic Risk
Systemic Risk
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Regulation Post-2007 Crisis
Regulation Post-2007 Crisis
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ISDA Master Agreement
ISDA Master Agreement
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Clearing
Clearing
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Bilaterally Cleared Transactions
Bilaterally Cleared Transactions
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Collateral in OTC Markets
Collateral in OTC Markets
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Central Clearing
Central Clearing
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Variation Margin for Futures
Variation Margin for Futures
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Variation Margin in OTC
Variation Margin in OTC
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Margin/Collateral
Margin/Collateral
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Haircut
Haircut
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Futures Quotes
Futures Quotes
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Settlement Price
Settlement Price
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Change (in Futures Quote)
Change (in Futures Quote)
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Volume (Futures)
Volume (Futures)
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Maturity Month
Maturity Month
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Opening Price
Opening Price
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Highest Price (Intraday)
Highest Price (Intraday)
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Lowest Price (Intraday)
Lowest Price (Intraday)
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Trading Volume
Trading Volume
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Open Interest
Open Interest
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Normal Market
Normal Market
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Inverted Market
Inverted Market
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Contango
Contango
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Backwardation
Backwardation
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Delivery (Futures)
Delivery (Futures)
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First Notice Day
First Notice Day
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Last Notice Day
Last Notice Day
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Closing Long Position Before Notice Day
Closing Long Position Before Notice Day
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Cash Settlement
Cash Settlement
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Futures Commission Merchants (FCMs)
Futures Commission Merchants (FCMs)
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Locals (Futures Trading)
Locals (Futures Trading)
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Scalpers (Futures)
Scalpers (Futures)
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Day Traders (Futures)
Day Traders (Futures)
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Position Traders (Futures)
Position Traders (Futures)
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Market Order
Market Order
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Limit Order
Limit Order
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Stop Order
Stop Order
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Stop-Limit Order
Stop-Limit Order
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Market-If-Touched (MIT) Order
Market-If-Touched (MIT) Order
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Discretionary Order
Discretionary Order
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Good-Till-Canceled (GTC) Order
Good-Till-Canceled (GTC) Order
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Fill-or-Kill order
Fill-or-Kill order
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Short-Term Capital Gains
Short-Term Capital Gains
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Long-Term Capital Gains
Long-Term Capital Gains
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Capital Losses (Noncorporate)
Capital Losses (Noncorporate)
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60/40 Rule
60/40 Rule
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60/40 Loss Carryback
60/40 Loss Carryback
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Hedging Transaction (Tax)
Hedging Transaction (Tax)
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Hedge Identification
Hedge Identification
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Hedging Gains/Losses
Hedging Gains/Losses
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Hedging Timing
Hedging Timing
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Forward Contract Characteristics
Forward Contract Characteristics
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Futures Contract Characteristics
Futures Contract Characteristics
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Forward Contract Profit Realization
Forward Contract Profit Realization
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Futures Contract Profit Realization
Futures Contract Profit Realization
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Futures Price Quotation (USD)
Futures Price Quotation (USD)
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Forward Price Quotation (non-USD)
Forward Price Quotation (non-USD)
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National Futures Association (NFA)
National Futures Association (NFA)
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Dodd-Frank Act (2010)
Dodd-Frank Act (2010)
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Cornering the Market
Cornering the Market
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Regulatory Response to Market Abuse
Regulatory Response to Market Abuse
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Trading Irregularities (Floor Trading)
Trading Irregularities (Floor Trading)
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Front Running
Front Running
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Mark-to-Market Accounting (Futures)
Mark-to-Market Accounting (Futures)
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Hedge Accounting
Hedge Accounting
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Accounting Gain Example without Hedge
Accounting Gain Example without Hedge
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Accounting Gain Example with Hedge
Accounting Gain Example with Hedge
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FAS 133 (Accounting for Derivatives)
FAS 133 (Accounting for Derivatives)
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Effectiveness Assessment (Hedge Accounting)
Effectiveness Assessment (Hedge Accounting)
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IAS 39
IAS 39
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Taxable Gain or Loss (Futures)
Taxable Gain or Loss (Futures)
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Corporate Tax Treatment (Capital Gains/Losses)
Corporate Tax Treatment (Capital Gains/Losses)
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Study Notes
- Futures and forward contracts are agreements to buy/sell an asset at a future date for a set price
- Futures contracts trade on exchanges with standardized terms
- Forward contracts trade over-the-counter (OTC) and can be customized
Background
- CME Group formed via merger of Chicago Board of Trade, Chicago Mercantile Exchange, and New York Mercantile Exchange
- Other major exchanges: InterContinental Exchange (ICE), Eurex, BM&F BOVESPA, and Tokyo Financial Exchange
- To initiate a futures contract, a broker buys or sells a contract on behalf of a trader
- A trader in New York might buy (long position) a September corn contract
- A trader in Kansas might sell (short position) a September corn contract
- Price is determined by open outcry or electronic matching based on supply and demand
Closing Out Positions
- Most futures contracts are closed out before delivery via an offsetting trade
- Example: A trader buys a September corn contract and later sells a September corn contract to close the position
- Delivery is unusual, but it ties the futures price to the spot price
Specification of a Futures Contract
- Exchanges detail the agreement including asset, contract size, delivery location, and delivery date
- For alternative asset grades or delivery locations, the short position typically selects the option
- The short position files a notice of intention to deliver with the exchange indicating asset grade and delivery location
The Asset
- For commodities, exchanges specify acceptable grades
- ICE specifies US Grade A frozen concentrated orange juice with a minimum Brix value of 62.5 degrees
- CME Group allows substitutions in its corn futures contract, adjusting the price accordingly
- Financial assets in futures contracts are generally well-defined e.g. Japanese yen
- US Treasury bond futures contracts can be any bond with 15-25 year maturity, price adjusted by a formula
Contract Size
- Exchanges set the amount of asset to be delivered per contract
- Too large may exclude smaller hedgers/speculators, while too small can raise trading costs
- Agricultural contracts may be 10,000−10,000-10,000−20,000, while financial futures like Treasury bonds are $100,000 face value
- "Mini" contracts attract smaller investors like the CME Group’s Mini Nasdaq 100 contract
Delivery Arrangements
- Delivery location is important, especially for commodities with transportation costs
- ICE orange juice contract delivery is to licensed warehouses in Florida, New Jersey, or Delaware
- Prices are adjusted for delivery location relative to main supply sources
Delivery Months
- Contracts are named by delivery month, which varies by contract
- CME Group corn futures deliver in March, May, July, September, and December
- Exchanges determine when trading starts and ends for a contract, usually a few days before the last delivery day
Price Quotes
- Exchanges define price quotes, e.g., dollars and cents for US crude oil, dollars and thirty-seconds for Treasury bonds/notes
Price Limits and Position Limits
- Daily price movement limits are specified
- A contract is "limit down" if the price decreases by the daily price limit
- A contract is "limit up" if the price increases by the daily price limit
- A limit move is a move equal to the daily price limit
- Trading usually stops when limit up or limit down is reached, but the exchange can change limits
- Limits prevent speculative excesses, but can obstruct trading during rapid price changes
- Position limits are maximum contracts a speculator can hold, preventing market manipulation
Convergence of Futures Price to Spot Price
- Futures price converges to the spot price as the delivery period nears
- During delivery, the futures price equals or is very close to the spot price
- If Futures price > Spot price, arbitrageurs sell futures, buy the asset, and deliver, lowering the futures price
- If Futures price < Spot price, companies buy futures and await delivery, raising futures price
The Operation of Margin Accounts
- Exchanges use margin accounts to avoid contract defaults
- Buying two December gold futures contracts at 1,450perouncerequiresaninitialmargindeposit;e.g.,1,450 per ounce requires an initial margin deposit; e.g., 1,450perouncerequiresaninitialmargindeposit;e.g.,6,000 per contract
- Daily settlement/marking to market adjusts the margin account daily
- If the futures price drops by 9,themarginaccountdecreasesby9, the margin account decreases by 9,themarginaccountdecreasesby1,800
- The investor can withdraw any balance above the initial margin
- Maintenance margin is lower than initial margin and if the balance falls below it, a margin call is issued, and the investor must restore the account to the initial margin level by the next day via variation margin
- Failure to provide variation margin leads to position closeout
- Trades are settled at the end of the trade day and subsequently at the close of each subsequent day
- Decreases in futures price = broker pays clearing house which is passed to investor with a short position. Increases result in payers for short and money to long positions.
Further Details
- Brokers pay interest on margin account balances
- Investors can deposit securities (Treasury bills at 90% face value or shares at 50% market value) to meet initial margin
- Futures contracts are settled daily, unlike forward contracts which settle at the end
- Minimum margin levels are set by the exchange clearing house, based on the underlying asset's price variability
- Maintenance margin is typically 75% of the initial margin
- Bona fide hedgers often have lower margin requirements than speculators due to lower default risk
- Day trades and spread transactions have lower margin requirements
- Margin requirements are the same for short and long futures positions
The Clearing House and Its Members
- Clearing houses act as intermediaries guaranteeing transaction performance
- Members must channel business through the clearing house and post margin
- Clearing Houses track daily transactions and calculate net positions of members
- Initial margin is based on total contracts cleared, with short/long positions netted
- Clearing house members contribute to a guaranty fund for use if a member defaults
Credit Risk
- The margin system ensures funds for profitable traders
- Clearing houses had enough funds to pay out short S&P 500 positions, even on October 19, 1987 when massive gains and a crash tested the system
OTC markets
- OTC markets involve direct derivatives deals without exchanges, and credit risk
- If one company in a derivatives deal defaults with a positive net value, the other takes the loss
- OTC markets now use exchange-traded markets ideas to cut credit risk
Central Counterparties
- CCPs are clearing houses for OTC deals, like exchange clearing houses
- CCP members give initial/variation margin and contribute to a guaranty fund
- After an OTC derivatives deal, a CCP becomes the counterparty to both parties, taking on credit risk
- CCP members must post initial margin
- Transactions are valued daily, with variation margin payments
- OTC market participants can clear through a CCP member, margins are paid to the CCP
Bilateral Clearing
- Bilaterally cleared OTC deals use a master agreement for all trades with a credit support annex (CSA) requiring collateral similar to margin
- Agreements value transactions daily; if value to party A rises by X, party B provides X collateral to A
- Collateral significantly reduces credit risk in the bilaterally cleared OTC market
- New regulations require initial/variation margin for bilaterally cleared deals
Futures Trades vs. OTC Trades
- Cash initial margin earns interest, daily variation margin for futures doesn't
- OTC transactions (via CCPs or bilaterally) are usually not settled daily
- Securities satisfy margin needs at a reduced market value called a haircut
Market Quotes
- Futures quotes come from exchanges and online sources
- They include underlying asset, contract size, and pricing
- Quotes include opening price, high, low, previous settlement price, price change, and volume
- The settlement price is the daily price used for calculating gains, losses, and margin requirements, and the volume is contrasted with open intrest (number of outstanding contracts)
Prices
- Open price reflects prices at the start of trading
- Settlement price calculates daily gains/losses and margin requirements
- The price is the most recent trading price, and change from the previous day’s settlement price indicates price increases for long position
Trading Volume and Open Interest
- Trading volume is number of contracts traded in a day
- Open interest is the number of contracts outstanding
Patterns of Futures
- Normal market: futures prices increase with contract maturity e.g., gold, wheat and live cattle
- Inverted market: futures prices decrease with maturity
Delivery
- Few futures contracts lead to delivery; most are closed out early
- Delivery is determined by the short position (investor A)
- Investor A's broker gives a notice of intention to deliver stating contracts, location, and grade
- The exchange picks a long position to accept delivery, usually the oldest
- In commodities, taking delivery means accepting a warehouse receipt in exchange for payment
- In financial futures, delivery is made by wire transfer
- The price paid is the most recent settlement price, adjusted for various factors
- The delivery takes two to three days after the notice of intention
- The first notice day marks the beginning of submission of delivery intention to the exchange
- The last notice day is the final day for submitting the delivery intention
- The last trading day is the final day to close out the position and thus avoid the risk of having to take delivery
- Avoid the delivery risk by closing contracts before the first notice day
Cash Settlement
- Some financial futures settle in cash due to impracticality of asset delivery e.g., S&P 500
- All contracts close on a set day, with the final settlement price equaling the spot price at the open/close
- S&P 500 futures contracts settle on the delivery month’s third Friday with the final settlement occurring at the opening price of the day
Types of Traders and Types of Orders
- FCMs follow client instructions for a commission
- Locals trade on their own account
- Traders are hedgers, speculators, or arbitrageurs
Orders
- Scalpers profit from minor price changes over minutes
- Day traders hold positions for less than one trading day
- Position traders hold positions for extended times
- Types of orders include Market orders, Limit orders, Stop orders, Stop-limit orders, Market-if-touched (MIT) orders, discretionary order or market-not-held order and those with time conditions
- A simple market order leads to immediate trade at the best price
- Limit order executes at a specific or better price
- "Stop order or stop-loss order" executes at best available price
- "Stop–limit order" is a mix of stop & limit orders
- "Market-if-touched" executed when a trade happens at a specific price or a better price
- "Time-of-day orders" are good for a particular time
- "Good-till-canceled orders" are in effect unti executed or until the end of trading in the contract
- "Fill-or-kill orders" must be fully executed immediately
Regulation
- The CFTC regulates US futures markets to protect public interest
- Their roles is to track prices, traders, and license services
- The NFA also prevents fraud, and promotes market interests
- The Dodd-Frank Act expanded the CFTC’s role overseeing OTC derivatives
Trading Irregularities
- Corners occur when investors control supply of underlying commodity which can result in large price increase
- Cornering the market can result in margin increases, or position limits
- Trading irregularities can involve traders front running resulting in overcharging customers
Accounting and Tax
- Accounting standards recognize changes in the market value of a futures contract unless the contract qualifies as a hedge,
- FAS 133 is related to derivatives and it requires all derivatives to be included on the balance sheet at fair market value.
- Non-corporate capital gains are taxed a max. 15%
Forward vs. Futures Contracts
- Forward contracts are private, not standardized, settle at maturity, and have some credit risk
- Futures contracts are exchange-traded, contract size is standard, settled daily, and have virtually no credit risk
- Forward contracts whole gain/loss is at end, while Futures, gains/losses are realized daily due to settlement procedures
Profits from Forward and Futures Contracts
- The sterling exchange rate for a 90-day forward contract is 1.5000 and the same rate price for future contract delivered in exactly 90 days.
- The difference bewteen the gains and losses under the two contracts is that while for forward, gains are made at the end of the life of the contract, with futures, the gains/losses are realized daily.
- They are always quoted in the same way
Foreign Exchange Quotes
- Active forward and futures currency contracts happen actively
- Futures prices with US dollar exchange are quoted as dollar per unit of foreign currency
- For the British pound, the Australian dollar, and the New Zealand dollar, forward quotes show the number of US dollars per unit of the foreign currency
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Description
Explore futures vs. forwards, exchange roles (e.g., CME Group), and long/short positions. Learn about margin accounts, electronic trading's impact, contract standardization, and open outcry. Understand alternative delivery locations.
