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Questions and Answers

What is a characteristic of the futures market?

It only exists for certain types of underlying assets. (correct)

It operates without any contract rigidity.

It completely replaces spot markets.

It features standardized forward contracts. (correct)

Which function does the Clearing House NOT perform?

Centralization of exchanges.

Daily margin calls to manage potential losses.

Settlement of all contract negotiations. (correct)

Daily valuation for counterparty risk management.

How is counterparty risk typically managed in OTC markets?

By eliminating the need for margin calls.

Through regulatory oversight only.

By utilizing a single standardized contract.

Via bilateral netting and collateralization. (correct)

In futures contracts, what element is NOT typically standardized?

Market price fluctuations. Signup and view all the answers

What is the primary role of a Clearing House in futures trading?

To manage the liquidity and counterparty risk. Signup and view all the answers

What is the primary function of a clearing house in the context of futures contracts?

To act as an intermediary between buyers and sellers Signup and view all the answers

Which of the following is NOT one of the three objectives of the G20 after the great crisis?

Promoting economic growth Signup and view all the answers

What are the methods of settlement for a futures contract?

Physical delivery, compensation, and cash settlement Signup and view all the answers

What does the term 'basis' refer to in the futures market?

The difference between the futures price and the spot price Signup and view all the answers

Which of the following represents a potential difficulty associated with clearing houses?

They can promote greater risk-taking behavior Signup and view all the answers

What is the consequence of a futures price being higher than the spot price just before the expiry of the contract?

Arbitrage opportunities may arise Signup and view all the answers

Which regulatory body in the US is responsible for overseeing commodity futures trading?

Commodity Futures Trading Commission (CFTC) Signup and view all the answers

What happens at the expiry of a futures contract?

Futures and spot prices must be equal Signup and view all the answers

Which of the following statements accurately describes the standardization of futures and forward contracts?

Futures contracts are highly standardized, while forward contracts are not standardized at all. Signup and view all the answers

What is a key feature of the liquidity in futures markets compared to forward markets?

Futures markets typically offer ample liquidity, whereas forward markets have almost zero liquidity. Signup and view all the answers

How does the initial outlay differ between futures and forward contracts?

Futures involve deposits or margin calls, whereas forwards typically require no payment. Signup and view all the answers

What aspect of hedging differentiates futures from forward contracts?

Hedging in futures is reversible and inexpensive, unlike forward hedging. Signup and view all the answers

Which of the following best captures the role of clearing houses in futures markets?

Clearing houses provide a central clearing mechanism to mitigate counterparty risk. Signup and view all the answers

What is the primary method of settlement for futures contracts compared to forwards?

Futures contracts may use cash settlement or physical delivery, whereas forwards usually settle through physical delivery. Signup and view all the answers

Which of the following transactions is not a characteristic of futures markets?

Futures transactions guarantee a set delivery date with no room for adjustment. Signup and view all the answers

Which of the following is a typical historical evolution of futures markets?

Futures markets for financial assets emerged significantly after the 1970s. Signup and view all the answers

Study Notes

G20 Objectives After The Great Crisis

Increase transparency
Mitigate systemic risk
Fight market abuse

Regulatory Reforms Post Great Crisis

Global reforms coordinated by the Financial Stability Board (FSB)
US: Dodd-Frank and Commodity Futures and Trading Commission (CFTC)
Europe: European Market Infrastructure Regulation (EMIR) and European Securities and Markets Authority (ESMA)

"Too big to fail" clearing houses present a moral hazard risk
Clearing houses may encourage greater risk-taking
Costs associated with clearing houses:
- Learning costs
- Treasury costs
Unbalanced markets for collateral assets

Futures Contract Conclusion

Physical delivery
Compensation (countertrade)
Cash settlement

Basis Convergence

Basis is the difference between future prices (F) and spot prices (S)
The basis converges at the expiry of the contract (T): F(T,T) = S(T)
Arbitrage opportunities arise when F(T,T) ≠ S(T)
Example:
- Physical price: 140
- Futures price: 145
- Profit: 5 (Sell futures and buy physical)
Consequence of arbitrage: Equality between physical and futures prices is restored through price adjustments

Role of The Futures Market

Standardized forward contracts traded on the futures market
Key details of contracts: Quality, volume, location, and date of delivery
Rigidity of contracts

Clearing House Roles

Liquidity function: Centralization of exchanges
Counterparty risk management:
- Daily settlement prices
- Margin calls
- Payment of profits and losses
- Deposit payment required for transactions

Counterparty Risk Management in OTC Markets

Bilateral netting
Collateralization / Initial Margin
Revaluation of collateral and margin call
Cleared OTC products through clearing houses

Differences Between Forwards and Futures

Futures	Forwards
Standardized transactions	Non-standardized transactions
Exceptional expiration with effective delivery	Normal expiration with effective delivery
Ample liquidity	Almost zero liquidity
Initial outlay includes deposit and margin calls	No initial payment required
Imperfect hedging, inexpensive, and reversible	Perfect hedging, costly, and irreversible

Brief History of Futures Markets

Cereals
Non-ferrous metals
Tropical products
Oilseed
Animals
Currencies
Financial fixed income
Petroleum products
Equity Indices

Key Dates for Derivative Markets

1850 – 1930: Forward market on agricultural products
1930 – 1970: Futures markets on raw materials
1970-1985: Futures markets on financial assets
1985-2000: The era of OTC markets
2000-…..: Towards a new organization of derivatives markets

Spot, Forward, and Futures Prices

Physical Market:
- Immediate delivery: Spot transaction, Spot price
- Delayed delivery: Forward transaction, Forward price
Contract Market: Futures transaction, Futures price
- Standardized
- Multiple futures prices for various delivery dates

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Description

Explore the objectives and regulatory reforms initiated by the G20 after the Great Crisis. This quiz covers key topics such as transparency, systemic risk mitigation, and the challenges faced by clearing houses. Test your understanding of futures contracts and basis convergence as well.