Ebook Financial markets and institutions (11th edition): Part 2

www.downloadslide.com PART 5 Derivative Security Markets Derivatives are financial contracts whose values are derived from the values of under-lying assets. They are widely used to speculate on future expectations or to reduce a security portfolio’s risk. The chapters in Part 5 focus on derivative security markets, and each explains how institutional portfolio managers and speculators use them. Many financial market participants simultaneously use all these markets, as is emphasized throughout the chapters. Futures Markets (Chapter 13) Speculation in Futures Institutional Portfolio Managers Hedging Security Portfolios against Risk International Securities Transactions Options Markets (Chapter 14) Swap Markets (Chapter 15) Foreign Exchange Derivative Markets (Chapter 16) Speculation in Options Speculators Speculation in Swaps Speculation in Currencies 341 Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. www.downloadslide.com Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. www.downloadslide.com 13 Financial Futures Markets CHAPTER OBJECTIVES The specific objectives of this chapter are to: ■ provide a background on financial futures contracts, ■ explain how interest rate futures contracts are used to speculate or hedge based on anticipated interest rate movements, ■ explain how stock index futures contracts are used to speculate or hedge based on anticipated stock price movements, ■ explain how single stock futures are used to speculate on anticipated stock price movements, and ■ describe the different types of risk to which traders in financial futures contracts are exposed. In recent years, financial futures markets have received much attention because they have the potential to generate large returns to speculators and because they entail a high degree of risk. However, these markets can also be used to reduce the risk of financial institutions and other corporations. Financial futures markets facilitate the trading of financial futures contracts. 13-1 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 financial futures contract buys the financial instrument, and the seller of a financial futures contract delivers the instrument for the specified price. 13-1a Popular Futures Contracts Futures contracts are traded on a wide variety of securities and indexes. Interest Rate Futures Many of the popular financial futures contracts are on debt securities such as Treasury bills, Treasury notes, Treasury bonds, and Eurodollar CDs. These contracts are referred to as interest rate futures. For each type of contract, the settlement dates at which delivery would occur are in March, June, September, and December. Stock Index Futures There are also financial futures contracts on stock indexes, which are referred to as stock index futures. A stock index futures contract allows for the buying and selling of a stock index for a specified price at a specified date. Various stock index futures contracts are described in Exhibit 13.1. 13-1b Markets for Financial Futures Markets have been established to facilitate the trading of futures contracts. Futures Exchanges Futures exchanges provide an organized marketplace where standardized futures contracts can be traded. The exchanges clear, settle, and guarantee all transactions. They can ensure that each party’s position is sufficiently backed by collateral as the market value of the position changes over time. In this way, any losses that occur are covered, so that counterparties are not adversely affected. Consequently, participants are more willing to trade financial futures contracts on an exchange. 343 Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 344 Part 5: Derivative Security Markets www.downloadslide.com Exhibit 13.1 Stock Index Futures Contracts TYPE OF STOCK INDEX FUTURES CONTRACT S&P 500 index Mini S&P 500 index S&P Midcap 400 index S&P Small Cap index Nasdaq 100 index Mini Nasdaq 100 index Mini Nasdaq Composite index Russell 2000 index CONTRACT IS VALUED AS $250 times index $50 times index $500 times index $200 times index $100 times index $20 times index $20 times index $500 times index WEB www.cftc.gov Detailed information on the CFTC. WEB www.nfa.futures.org Information for inves-tors who wish to trade futures contracts. Most financial futures contracts in the United States are traded through the CME Group, which was formed in July 2007 by the merger of the Chicago Board of Trade (CBOT) and the Chicago Mercantile Exchange (CME). The CBOT specialized in futures contracts on Treasury bonds and agricultural products, and also traded stock options (described in the next chapter). The CME specialized in futures contracts on money market securities, stock indexes, and currencies. The CME went public in 2002, and the CBOT went public in 2005. Their merger to form the CME Group created the world’s largest and most diverse derivatives exchange, which serves international markets for derivative products. As part of the restructuring to increase efficiency, the CME and CBOT trading floors were consolidated into a single trading floor (at the CBOT) and their products were consolidated on a single electronic platform, which has reduced operating and maintenance expenses. The operations of financial futures exchanges are regulated by the Commodity Futures Trading Commission (CFTC). The CFTC approves futures contracts before they can be listed by futures exchanges and imposes regulations to prevent unfair trading practices. Over-the-Counter Market Some specialized futures contracts are sold “over the counter” rather than on an exchange, whereby a financial intermediary (such as a com-mercial bank or an investment bank) finds a counterparty or serves as the counterparty. These over-the-counter arrangements are more personalized and can be tailored to the specific preferences of the parties involved. Such tailoring is not possible for the more standardized futures contracts sold on the exchanges. 13-1c Purpose of Trading Financial Futures Financial futures are traded either to speculate on prices of securities or to hedge existing exposure to security price movements. Speculators in financial futures markets take positions to profit from expected changes in the price of futures contracts over time. They can be classified according to their methods. Day traders attempt to capitalize on price movements during a single day; normally, they close out their futures positions on the same day the positions were initiated. Position traders maintain their futures posi-tions for longer periods of time (for weeks or months) and thus attempt to capitalize on expected price movements over a more extended time horizon. Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. www.downloadslide.com Chapter 13: Financial Futures Markets 345 Hedgers take positions in financial futures to reduce their exposure to future move-ments in interest rates or stock prices. Many hedgers who maintain large portfolios of stocks or bonds take a futures position to hedge their risk. Speculators commonly take the opposite position and therefore serve as the counterparty on many futures transac-tions. Thus, speculators provide liquidity to the futures market. WEB 13-1d Institutional Trading of Futures Contracts www.cmegroup.com Offers details about the products offered by the CME Group and also provides price quota-tions of the various futures contracts. Exhibit 13.2 summarizes how various types of financial institutions participate in futures markets. Financial institutions generally use futures contracts to reduce risk. Some commer-cial banks, savings institutions, bond mutual funds, pension funds, and insurance compa-nies trade interest rate futures contracts to protect against a possible increase in interest rates, thereby insulating their long-term debt securities from interest rate risk. Some stock mutual funds, pension funds, and insurance companies trade stock index futures to partially insulate their respective stock portfolios from adverse movements in the stock market. WEB 13-1e Trading Process www.bloomberg.com Today’s prices of U.S. bond futures contracts and prices of currency futures contracts. When the futures exchanges were created, they relied on commission brokers (also called floor brokers) to execute orders for their customers, which generally were broker-age firms. In addition, floor traders (also called locals) traded futures contracts for their own account. The commission brokers and floor traders went to a specific location on the trading floor where the futures contract was traded to execute the order. Market-makers can also execute futures contract transactions for customers. They may facilitate a buy order for one customer and a sell order for a different customer. The market-maker earns the difference between the bid price and the ask price for such a trade, although the spread has declined significantly in recent years. Market-makers also earn profits when they use their own funds to take positions in futures contracts. Like any investors, they are subject to the risk of losses on their positions. Electronic Trading Most futures contracts are now traded electronically. The CME Group has an electronic trading platform called Globex that complements its floor Exhibit 13.2 Institutional Use of Futures Markets TYPE OF FINANCIAL INSTITUTION Commercial banks Savings institutions Securities firms Mutual funds Pension funds Insurance companies PARTICIPATION IN FUTURES MARKETS ... - tailieumienphi.vn