Chapter 10 - Forward and Futures Contracts Examples

Chapter 10 Forward and Futures Contracts
174

10.1 Learning Objectives:
At the end of this topic you are expected to be able to: Define the forward contract Explain the mechanisms involved in forward contracts Define the futures Contract Explain the mechanism of futures trading Contrast futures contracts from forward contracts.
10.1.1
Forward Contracts
A forward contract is a particularly simple derivative security. It is an agreement to buy or sell an asset at a certain future time for certain price. The contract is usually between two financial institutions or between a financial institution and one of its corporate clients. It is not normally traded on an exchange.
What are the parties to the forward contract?

o One of the parties to a forward contract assumes a long position and agrees to buy the underlying asset on a certain specified future date for a certain specified price. The other party assumes a short position and agrees to sell the asset on the same date for the same price.
What are Other Features of the Forward Contract?

(i) Delivery Price
The specified price in a forward contract will be referred to as the delivery price. At the time the contract is entered into, the delivery price is chosen so that the value of the forward contract to both parties is zero.11 this means that it costs nothing to take either a long or a short position. (ii) Short vs. Long Position
A forward contract is settled at maturity. The holder of the short position delivers the asset to the holder of the long position in return for a cash amount equal to the delivery price. A key variable determining the value of a forward contract is the market price of the asset. As already mentioned, a forward contract is worth zero when it is first entered into. Later it can have a positive or a negative value depending on movements in the price of the asset. For example, if the price of the asset rises sharply soon after the initiation of the contract, the value of a long position in the forward contract becomes
1
In a later chapter we explain the way in which this delivery price can be calculated
175
positive and the value of a short position in the forward contract becomes negative.
10.1.2
The Forward Price
The forward price for a certain contract is defined as the delivery price, which would make that contract have zero value. The forward price and the delivery price are therefore equal at the time the contract is entered into. As time passes, the forward price is liable to change while the delivery price, of course, remains the same. The two are not therefore equal, except by chance, that any time after the start of the contract. Generally, the forward price at any given time varies with the maturity of the contract being considered. For example, the forward price for a contract to buy or sell in 3 months is typically different from that for a contract to buy or sell in 6 months.
Table 10.1 Spot and February 09, 2005

Spot 30-day forward 90-day forward 180-day forward 1,728 0 1,720 8 1,709 0 1,692 9
Forward
Foreign
Exchange
Quotes,
Corporations frequently enter into forward contracts on foreign exchange. Consider the quotes shown in Table 7.1 for the pound sterling U.S. dollar exchange rate on February 9, 2005. The first quote indicates that, ignoring commissions and other transactions costs, sterling can be bought or sold in the spot market (that is, for virtually immediate delivery) at the rate of $1.7280 per pound; t The second quote indicates that the forward price (or forward exchange rate) for a contract to buy or sell sterling in 30 days is $1.7208 per pound; the third quote indicates that the forward price for a contract to buy or sell sterling in 90 days is $1.7090 per pound; and so on.
10.1.3
Payoffs From Forward Contracts
The pay from a long position in a forward contract on one unit of an asset is ST - K Where K is a delivery price and ST is the spot price of the asset at maturity of the contract. This is because the holder of the contract is obligated to buy an asset worth ST for K.
176
Similarly, the payoff from a short position in a forward contract on one unit of a asset is K ST These payoffs can be positive or negative. They are illustrated in Figure 7.1. Since it costs nothing to enter into a forward contract, the payoff from the contract is also the investors total gain or less from contract. Payoff Payoff
St
St
Long Position
short position
Figure 10.1 Payoffs Forward Contract.

The two parts to the contract do not necessarily know each other the exchange also provides a mechanism, which gives the two parties a guarantee that the contract will be honored.
10.1.4
Homemade Forward Contracts
Suppose that you borrow $90. 91 for one year at 10 percent and lend $90.91 for two years at 12 percent. These interest rates are for loans made today; therefore, they are spot interest rates. The cash flows on your transactions are as follows: Borrow for 1 year at 10% Lend for 2 years at 12% Net cash flow Year 0 +90.9 1 -90.91 0 Year 1 -100 Year 2 +114.04 -100 +114.04
Notice that you do not have any net cash outflow today but you have contracted to pay out money in year 1. The interest rate on this forward commitment is 14.04 percent. To calculate this forward interest rate, we simply worked out the extra return for lending for two years rather than one: In our example, you manufactured a forward loan by borrowing short-term and lending long. But you can also run the process in reverse. If you wish to fix today the rate at which you borrow next year, you borrow long and lend the money until you need it next year.
177
Use of money markets for managing currency risk

It is possible to cover the risk of adverse exchange rate movements by using the money markets. Suppose you are the financial controller in a UK company expecting to receive US dollars from a customer in 6 months time. The company therefore has a dollar asset, the debtor, and is exposed to the risk of the US$ weakening against the during the six month period. The money market can be used to create a matching dollar liability in order to eliminate the exchange risk on the debtor. The company should therefore borrow an appropriate amount of US$ today which can be sold today, at the spot rate in exchange for thereby fixing the exchange rate today and eliminating the exchange rate risk. The company would then use the $ received in 6 months time to pay off the loan. Example below shows how this could be done
Illustrative Example 1
Starter Ltd is due to receive $50,000 in 1 years time. The company can borrow $ at a rate of 12% per annum.
Required
Explain how Starter Ltd could use the money market to hedge the currency risk o this debtor.
Solution
It is first necessary to calculate the amount of $ to borrow now in order to have balance outstanding (initial loan + interest) of $50,000. Let $x be the amount borrowed now so that: $x(1 + 0.12) = $50,000
Therefore $x = $50,000/1.12 = $44,643 = amount of loan taken out today. In effect we are calculating the present value of the $50,000 using the rate of interest on the loan (for the appropriate time period) as the discount rate. This will have the following effects: 1. The $44,643 proceeds from the loan can be converted to TShs at the spot rate today. This fixes the exchange rate today and therefore eliminates the exchange risk.
178
2. The $50,000, when received, will exactly pay off the loan, assuming the customer pays on time! 3. The funds (TShs) can be used now for investment to increase the amount of TShs received by the year-end when payment is due. Point (3) is important when comparing use the money market and the forward market because, as we will see in the next section, if the company were using the forward market the TShs funds would not be available to the company until the date the company is due to receive the foreign currency from the customer. In this example, this would be at the end of the year. The money market can also be used by a URT company importing goods, which are invoiced in a foreign currency. The URT Company can use the money market to create an asset, in foreign currency, which can be matched against the liability to the supplier. Illustrative Example 2 illustrates this situation.
Dada Ltd, A URT Company, is due to pay SAR 240,000 in 3 months time to Isidingo SA a supplier in the South Africa. The relevant rates are as follows: Money market rates (% per year) Deposit Borrowing 4% 8% 5% 9%
URT South Africa Spot rates, TShs/SAR: 50 55
Required
Demonstrate how Dada Ltd can use the money markets to hedge the currency risk. Assuming the funds are obtained by borrowing sterling calculate the TShs cost of the transaction in three months time.
Solution
Dada Ltd will need to create a SAR asset now which can be used to meet the SAR liability in three months time. Therefore, it will have to buy SAR now and deposit the SAR for three months (the three month interest rates are found by multiplying the annual rates by 3/12- i.e. 5%X3/12): Let x be the number of SAR Dada Ltd needs to invest now. Therefore: x [1 +(.05 3/12)] x[1.0125] X x = 240,000 = 240,000 = 240,000 = 237,037 SAR

1.0125 The TShs cost of the SAR would be: 237,037 x 55 = TShs 13,037,035.
179
Dada Ltd would therefore borrow TShs 13,037,035. This would result in a TShs liability in three months time, including interest on the loan, of: 13,037,035 x ([1 + (0.08 x 3/12)] = 13,037,035 x 1.02 = TShs 13,297,776 As we will see in the next section, if a forward contract were used to hedge this transaction, the cost would be incurred in three months time. Hence the TShs 13,297,776 cost of the money market hedge is directly comparable with the cost when using a forward contract. As earlier pointed out: -
A forward foreign exchange contract is an agreement, entered into today, to purchase or sell a fixed quantity of a commodity, currency or other financial instrument on a fixed future date at a price fixed today. Now let us see the important
features of forward contracts;
1. The exchange rate is agreed today but the currencies are exchanged in the future (this contrasts with use of the money markets where the foreign currency is bought or sold today). 2. They are tailor made, that is they meet the exact requirements of the user. 3. Once entered into the forward foreign exchange contract must be completed. 4. The forward exchange rate will, as per the International Fisher effect, reflect the differential in interest rates between the two countries. The Illustrative Example below deals with the use of a forward contract to hedge the transaction exposure faced by a company and highlights a drawback of using forward contracts.
Illustrative Example 2.
Dafoor PLC, a UK company, is due to receive $500,000 in 6 months time; the spot rate is $1.40/. It is possible to enter into a forward contract to sell $500,000 in 6 months time at an exchange rate of $1.35/.
Required
Calculate the amount Dafoor PLC will receive in sterling assuming the spot rate in 6 months time is (a) $1.28 and (b) $1.62
Solution
(a)
180
Dafoor PLC 370,370
will
receive 1.35
500,000
With the benefit of hindsight, Dafoor PLC would have been better off without the forward contract; It could have sold the $ at the spot rate and received: 500,00 0 1.28 = 390,625
But that is not possible because, once entered into, the forward contract must be closed out. (b) Dafoor PLC will receive 370,370. However in this situation the forward contract has served its purpose: it has protected Dafoor PLC from a loss caused by a movement in the currency exchange rate. Without the forward contract the company would only have received: = 308,642
500,00 0 1.62
This could have eliminated the intended profit on the transactions. A major problem with a forward contract is the fixed settlement date. There are two ways in which to overcome this problem.
1.
Option forward contract
An option forward contracts (also known as a forward option contract, option date forward contract or forward option dated contract). This is not the same as a currency option contract explained in this chapter. An option forward contract offers the same arrangement as a forward contract except that there is a choice of dates on which the user can exercise the contract. This is either: on any date up to a specified date or at any time between 2 future dates. In either case the forward rate that applies would be the forward rate, in the period in which the contract can be exercised. That is least favourable to the purchaser of the contract.
2.
A forward/forward exchange contract
A forward/forward exchange contract (also known as forward/forward swap or forward swap) is two forward exchange deals entered into simultaneously with different maturity dates, one to buy the currency the other to sell the same amount of currency. If a company is unsure as to exactly when it will receive some foreign currency it can take the following action:

1. 2.
181
Enter into a forward contract today to sell the foreign currency on an arbitrary future date. When the exact date is known enter into a forward/forward exchange contract. This contract will involve: (a) (b) Buying the foreign currency on the date of the forward contract in 1: this will liquidate the first forward contract. Selling the foreign currency on the date on which the company is to receive the foreign currency.
It is important to note that the exchange rates under the forward/forward exchange contract are likely to differ from the rates under the original contract. A similar arrangement is a spot/forward contract in which the foreign currency is simultaneously bought and sold on different dates but this time the first date is today and therefore the exchange rate for this side of the transaction will be the spot rate. A spot/forward contract could be used when, for example, a customer fails to pay on time and a new payment date is agreed.
10.1.5
Forward Exchange Contracts.
What is a forward exchange contract?
As pointed out earlier foreign exchange transaction exposure can be overcome by means of a forward exchange contract, whereby the importer or exporter arranges for a bank to sell or buy quantity of foreign currency at a future date, at a rate of exchange that is determined when the forward contract is made. Forward exchange contracts allow a trader who knows that he will have to buy or sell foreign currency at a date in the future, to make the Purchase or sale at a predermined rate of exchange. The trader will therefore know in advance earlier how much local currency he will receive (if he is selling local currency to the bank) or how much local currency he must pay (if he is buying foreign currency from the bank)
10.1.5.1
A forward Price:
Is the spot price ruling on the day a forward exchange contract is made plus or minus the interest differential for the period of the contract.
Tutorial Note:
It is wrong to think of a forward rate as a forecast of what the spot rate will be on a given date in the future, and it will be a coincidence if the forward rate turns out to be the same as the spot rate on that future date. It is however likely that the spot rate will move in the direction indicated by the forward rate i.e. the forward rate is an unbiased estimator of the future spot rate.
182
Comprehensive Illustrative example 3

The finance director of Pluto Inc, a large New York based company, has been studying exchange rates and interest rates relevant to the United Kingdom and the USA. Pluto Inc has purchased goods from the United Kingdom at a cost of 2,350,000 payable in shillings in 3 months time. In order to maintain profit margins the finance director whishes to adopt, if possible, a risk frees strategy that will ensure that the cost of the goods to Pluto is no more than 3,555,000.
Exchange rates (New York)

$ Spot 1 3 Month forward months forward 1.4735 - 1.4755 1.4896 - 1.4933 1.5163 - 1.5181
Interest rates (available to Pluto Inc)
Deposit 1 Month 3 Months Required:

(a)
New York Borrowing rate (%) 16.50 17.00
Deposit rate (%) 6.5 6.75
London Borrowing rate (%) 10.50 10.75
rate (%) 13.25 13.25
Calculate whether it is possible for Pluto Inc to achieve a cost directly associated with this transaction of no more than 3,555,000 by means of a forward market hedge, money market hedge or a lead payment transaction costs may be ignored. (15 marks)
(b)
If, after one month, the British supplier was to suffer a fire which destroyed all stock and meant that the contract could not be fulfilled, and Pluto had bought pounds three months forward to pay for the goods, what action would you suggest that Pluto should take on the foreign exchange markets? Assume that three is no insurance protection for Pluto Inc. (5 marks)

(c)
183
What is an option forward contract? Would such a contract be value of Pluto Inc in this situation? marks) marks) (Total: 25 (5
Solutions and discussions:

(a)
Forward market hedge

Buy 2.35m three months forward an exchange rate of $1.5181. These costs: 2.35m x 1.5181 = $3,567,535 payable in three months time.
Money market hedge

The money market hedge uses the matching principle. The company has a 2.35m liability, which matures in three months time. To hedge it creates a matching 2.35m asset, which also matures in three months time. This asset is created by buying x now and placing them on three-month deposit, at an interest rate of 6.75% 4= 1.6875% so that capital plus interest accumulate to 2.35m in three months. The 2.35m invoice is then paid using the contents of the deposit account. Therefore, in order to hedge, the company needs to buy, at spot, x where: x (1 + 0.016875) = 2.35m x = 2.35m 1.016875 = 2,311,000 The cost of buying 2.311m spot is 2,311,000 x 1.4755 = $3,409,880 payable now.
Leading hedge
In this hedge the credit period is ignored and the invoice is paid immediately, buying the required at spot, to cost: 2.35m x 1.4755 = $3,467,425 payable now
The hedge compared :

(a) (b) (c) Forward market hedge: Money market hedge: Leading hedge: $3,567,535 payable in three months $3,409,880 payable now $3,467,425 payable now.
184
These three outcomes not all comparable because of time differences, and therefore to put them all on a common time footing, the money market hedge cost and the leading hedge cost are compounded forward three months (at which time the invoice is due to be paid) at the $ loan interest rate (assuming that making payments now would require money to be borrowed) of: 17% x 3/12 = 4.25%. $3,409,880 (1 + 0.0425) = $3,554,800 $3,467,425 (1 + 0.0425) = $3,614,791
Money market hedge: Leading hedge:
Now, on this basis, it can be seen that not only is the Money market hedge the least-cost hedging device, but it is the only one that satisfies Plutos criterion. Pluto no longer requires the bought forward. However, the delivery of currency amounts on forward contracts must take place. Therefore, to hedge any further FX risk exposure, Pluto should sell 2.35m two months forward. They will then know precisely how much is going to be the net cost of the forward purchase and sale of 2.35m. An option forward contract (its proper name is a time-option forward contract) is a forward contract where exchange of currencies can take place at any time between two specific future dates. Such contracts may be used where, for example, an exporter is unsure about the precise future date that he will receive the foreign currency proceeds of an export deal. Such a contract would be of no use Pluto Inc in this situation.
(b)
(c)

A German company has imported goods from USA and has been invoiced for US $ 240,000 payable in three months time. In addition, it has exported goods to Peru and has invoiced the customer for US $ 69,000 payable in three months time and has also exported goods to Australia and invoiced the customer for A$295,000 payable in four months. FX Rates US$/ Spot 3 Month /A$ Spot 4 month Money Market rates US$ A$
0.5830 0.5850 0.5520 0.5545 2.8890 2.8920 2.9510 - 2.9540 10% - 12% 14% - 16% 11.5% - 13%
Chapter 10 Forward and Futures Contracts Required

Show how the German Company might hedge its FX risk using: (a) The forward markets; (b) The money markets; And advise the company on which hedging strategy would be best. marks)
185
(15
Solutions and discussions:

As the German has a US$ asset ($ 69,000) and liability ($240,000) maturing at the same time (3 months), they can be used to offset each other and just the net liability: US$ 171,000, HEDGED.
Forward Market Hedge
Buy US 171,000 three months forward at a cost of: $171,000 0.5520 = 309,783 payable in three month time.
Money market hedge
Creating a matching US$ asset by placing US$x on deposit for 3 months at an interest rate of 2.5% so that capital plus interest accumulate to US$171,000 US$X (1 + 0.025) = US$171,000 US$x = US$171,000 1.025 = US$166,829 In three months time the liability to pay US$171,000 can be met by using the contents of the deposit account. In Order To Place The US$ on deposit they need to be bought at spot, costing: US$166,829 0.5830 = 286,156 payable now.
The German company also has an A$ asset of A$295,000 maturing in four months time which requires hedging.
Sell A$295,000 four months forward to yield: A$x 295,000 x 2.9510 = 870,545 received in four months time,
Money market hedge
As the German company has an AS $295,000 asset it needs to create a matching liability It should borrow A$x such that capital plus interest (at 5.33%) will accumulate to A$295,000 in four months times: A$x (1 + 0.0533) = A$295,000
186
A$ = a$295,000 1.0533 = A$280,072 These A$ should be sold at spot to yield: A$280,072 X 2.8890 = 809,128 received now The A$ loan can be repaid in four month time using the A$295,000 received from the customer. The best hedge: US$ Liability Forward market Money market Now 286,156 3 Months 309,783
Compounding the cost of the money market hedge forward three months at the DM deposit rate of 3.83% produces: DM 809,128 (1 + 0.0383)= DM 295,456. As this is less than the cost of the forward market hedge, the money market hedge is preferred.
A$ asset Now Forward market Money market 809,128 3 Months 870,545
Compounding the receipt from the money market hedge four months forward at the DM deposit rate of 3.83% produces: 809,128 (1 + 0.0383) = 840,118. As this is less than the outcome of the forward market hedge, the forward market hedge is preferred.

(a) Briefly discuss four techniques a company might use to hedge against the foreign exchange risk involved in foreign trade [8 Marks] (b) Frito is a medium sized UK Company with exports and import trade with the USA. The following transactions are due within the next six months. Transactions are in the currency specified. 1. Purchases of components, cash payment due in three months: 2. Sale of finished goods, cash receipt due in three months 3. Purchase of finished for resale, cash payment due in six months: 4. Purchase of finished goods for resale, cash payment due in Six GBP 116,000 $ 197,000 $ 447,000 $ 154,000

months:
187
Exchange rates (London Market)

$: GBP Spot Three months forward Six months forward 1.7106 1.7140 0.82 0.77 cents pm 1.39 1.34 cents pm
Money market Interest rates

Three months or six months Sterling Dollars Borrowing 12.5% 9% Lending 9.5% 6%
Required
Calculate the net Sterling receipts /payments that Frito might expect for both its three and six months transactions if the company hedges foreign exchange risk on: (a) The forward foreign exchange market (b) The money market [12 Marks]
Total [20 Marks] Solutions and Discussions:

(a)
(i) Forward market

This involves a contract which is tailor made i.e., is taken out for exact amount of currency required .The future rate of exchange is fixed at the time of contract is entered into with the bank. The cost is determined by the forward rate quoted by the bank .The contract must be fulfilled on the due date (or within the due dates for an option forward contact). Therefore if, for example, a customer is late in paying, the firm will have to buy currency in order to meet the commitment under the forward contract.
(ii) Financial futures

This offers the opportunity to buy /sell currency in standard amounts of a limited number of currencies at a specified time and rate. It is therefore cheaper than using a forward contract but can not usually obtain the exact amount of currency needed and requires an initial deposit.
(iii)
Lead/Lag payment
188
In the case of paying for goods in a foreign currency, it is possible to pay for the goods in advance and thereby fix the exchange rate at the spot rate. The cost is the time value of money between the normal due date and the earlier payment date.
(iv)Money market
Here the currency is exchanged at the time of the initial transaction at the spot rate and the currency is then lent/borrowed on the money market so as to accrue to the appropriate amount to settle the transaction on the due date. The cost will be determined by the interest rate differential between the two countries.
(v) Foreign currency options

Here the firm buys the possibility of buying (call) or selling (`put) currency at an agreed rate, usually at any time within specified period. It is possible to obtain a choice of exercise prices and maturity dates; the price of the option will vary according to the exercise price and maturity date chosen. Because options give the holder the opportunity to `walk away from the contract if it suits him, options are more expensive means of covering foreign exchange risk.
(vi)Invoice in the domestic currency:

For exports it is possible to invoice in the domestic currency. This is easier for the exporter but it passes the inconvenience and risk of foreign exchange on to the customer so it may result in lower sales. (b) An analysis of receipts and payments for Frito Ltd is worked out in the following working Three months GBP 116,000 Payment $ 197,000 Receipt Net Payments Six months $ 447,000 Payment $ 154,000 Receipt $ 293,000 Payment
(a) Forward Market

Three months: contact to sell $: $ 197,000 = GBP 115,454 receipt in three months
1.714 0.0077
Net Payment: 116,000 115,454 = GBP 546 $ Six months: contract to buy $: 293,000 = GBP 172,688 Payments

1.7106 0.0139
189
(b) Money Market

Three months: borrow and invest so as to create an equivalent $ liability (Cost +interest) to be matched with the existing $ Asset of $ 197,000. Borrowing interest rate in three months = 9% x 3/12 = 2.25% $ 197,100 = $ 192,665 (1+0.0225) Convert at spot: $ 192,665(i.e. Sell $) 1.714 = GBP 112,407 now - Invest for three months
Proceeds for three months: GBP 112,407 X [1+(0.095x3/12)] = GBP months 115,076 in three
Net Payment= 116,000 115,076 = GBP 924 Six months: Lending amount is calculated as follows: $ 293,000 (1+ (0.06x 6/12)] = $ 284,467
Need to buy $ now 1.714 0.0077
Cost $ 284,467 = GBP 166,296 1.7106
Borrow GBP for six months, have to repay: GBP 166,296 x (1+0.125x6/12)] = GBP 176,690

A Tanzanian Company has imported goods from the USA and has been invoiced for US$480,000 payable in three months time. In addition, it has exported goods to Peru and has invoiced the Customer for US$138,000 payable in three months time. It has also exported goods to Australia and invoiced the customer for A $590,000 payable in four months time. You are given the following foreign exchange rates:
US$/TZS TZS/A$
Spot 3 Months Spot 4 Months
0.0008830 0.0008850 0.0008520 0.0008545 288.90 289.20 295.10 295.40
190
Money Market Rates

US$ A$ TZS 10% - 12% 14% - 16% 11.5% - 13%
(a) Show how the Tanzania Company might hedge its foreign exchange risk using: (i) (ii) The Forward Market The Money Market (6 marks) (6 marks)
(b) Advise the company on which hedging strategy would be best. (8 marks) (Total: 20 marks) (a) As the Tanzanian Company has a US$ asset (US$138,000) and liability (US$480,000) maturing at the same time (3 months), they can be used to offset each other and adjust the net liability: US$342,000, hedged. (i) Forward Market Hedge Buy US$342,000 three months forward at a cost of: US$342,000 0.0008520 = TZS 401,408.70 payable in three months time.
(ii)
Money Market Hedge

Creating a matching IS$ asset by placing US$ x on deposit for three months at an interest rate of 2.5% so that capital plus interest accumulate to US$342,000. US$ x (1.025) = US$342,000 US$ x = US 342,000 1.025 =US$333,658.50 In order to place the US$342,000 on deposit, they need to be bought at spot costing: US$342,000 0.0008830 = TZS 387,315,968.30 payable now. The Tanzanian Company also has an A$ asset of A$590,000 maturing in four months time which requires hedging.

Sell A$590,000 four months forward to yield A$590,000 x 295.10 TZS 174,050,000 received in four months time.
Money Market Hedge

As the Tanzania Company has an A$590,000 asset, it needs to create a matching liability. It should borrow A$ x such that capital plus interest (at 5.33%) will accumulate to A$590,000 in four months time Thus: A$ x = A$590,000 1.0533 = A$560,144.30 These A$ should be sold spot to yield A$560,144.30 x 288.90 =TZS 161,825,688.30 received now. Comparing the Hedging Alternatives US Liability
Now
Three Months

Forward Market Money Market TZS 401,408,450.70 TZS 387,315,968.30
191
Compounding the cost of the money market hedge forward three months at the TZS loan rate of 3.25% to gain a comparative figure to the forward market hedge gives: TZS 387,315,968.30 (1.0325) =TZS 399,903,737.30. this is less than the forward market hedge. The money market hedge is preferred. A$ Asset
Now
Forward Market Money Market TZS 161,825,688.30
Four Months
TZS 174,050,000.00
Compounding the receipts from the money market hedge four months forward at the TZS deposit rate of 3.88% produces: TZS 161,825,688.30 (1.0383) = TZS 168,023,612.20, as this is less than the outcome of the forward market hedge. The market hedge is preferred.
10.2 Futures Contracts

A futures contract, like a forward, is an agreement between two parties to buy or sell an asset at a certain time in the future for a certain price. Unlike forward contracts, futures contracts are normally traded on an exchange. The two parties to the contract do not necessarily know each other the exchange also provides a mechanism, which gives the two parties a guarantee that the contract will be honored. The largest exchanges on which futures contracts are traded are the Chicago Board of Trade (CBOT) and the Chicago Mercantile Exchange (CME). On these and other exchange, a very wide range of commodities and financial assets form the underlying assets in the various contracts. The commodities include pork belies, live cattle, sugar, wool, lumber, copper, aluminum. Gold, and tin. The financial assets include stock indices, currencies, Treasury bills, and bonds.
One way in which a futures contract is different from a forward contract is that exact delivery date is not usually specified. The contract is referred to by its delivery month,
192
and the exchange specifies the period during the month when delivery must be made. Or commodities, the delivery period is often the whole month. The holder of the short position has the rights to choose the time during the delivery period when he or she will make delivery. Usually, contract with several different delivery month are traded at any one time. The exchange specifies the amount of the assets to be delivery for one contract how the futures price is to be quoted; and possibly, limits on the amount by which the future price can move in any one day. In the case of commodity, the exchange also specified the product quality and the delivery location. Consider for example; the wheat future contract currently traded in the Chicago Board of Trade. The size of the contract is 5,000 bushels. Contract for five-delivery month (March, May, July, September, and December) are available for up to one year into the future. The exchange specifies the grades of wheat that can be delivered and the places where delivery can be made. Future prices are regularly reported in the financial press. Suppose that, on September 1, the December future price of golds quoted at $ 500. This is the price, exclusive of commissions, at which investors can agree to buy or sell gold for December delivery. It is determined on the floor of the exchange in the same way as other price (that is, by he laws of supply and demand). If more investors want to go short, the price goes up; if the price goes down.2
10.2.1
Types of financial futures contract:
There are three types of financial futures contract 1. Interest rate futures 2. Currency futures and 3. Stock index futures
10.2.2
Trading with futures contract
Unlike forward contracts, futures contracts are normally traded on an exchange. To make trading possible, the exchange specifies certain standardized features of the contract. As the two parties to the contract do not necessarily know each other, the exchange also provides a mechanism, which gives the two parties a guarantee that the contract will be honored. The largest exchanges on which futures contracts are traded are the Chicago Board of Trade (CBOT) and the Chicago Mercantile Exchange (CME)
As we will see in a later section, a futures price can sometimes to the price of the underlying asset (gold, in this case).
193
On these and other Exchanges, a very wide range Commodities and financial assets form the underlying assets in the various contracts. The commodities include pork bellies; live cattle, sugar, wool, lumber, copper, aluminum, Gold and tin. The financial assets include stock indices, currencies, treasury bills and bonds. One way in which a futures contract is different from forward contract is that an exact delivery date is not usually specified, The contract is referred to by its delivery month, and the exchange specifies is referred to by its delivery month, and the exchange specifies the period during the month when delivery must be made.
How then does the actual trading take place?

For Commodities, the delivers period is often the whole month. The holder of a short position has the right to choose the time during the delivery when he or she will make delivery. Usually, contracts with several different delivery months are traded at any one time. The exchange specifies: The amount of the asset to be delivered for one contract How the futures contract price is to be quoted and, Possibly, limits on the amount by which the futures price can move in any one day In the case of a commodity, the exchange also specifies the Product Quality and Delivery location
Illustrative Example 6:
The wheat futures contract currently traded on the Chicago Board of Trade. The size of contract is 5,000 bushels; contracts are for five delivery months (March, May, July, September and December) are available up to year into the future.
What specifications will be given by the exchange?
The exchange specifies the grades of wheat that can be delivered and the places where delivery can be made. Futures prices are regularly reported in the financial press. Suppose that, on September 1, the December futures price of gold is quoted at $500. This is the price, exclusive of Commission, at which investors can agree to buy or sell gold for December delivery. If is determined on the floor of the exchange in same ways as other prices (that is by laws of demand and supply) id more investors want to go long than to go short, the prices goes up, if the reverse is true, the prices goes down. We are now in a position to examine in detail the mechanism involved in futures:
194
Mechanism in futures trading
Suppose if is march and you call your broker with instructions to buy, at the market price, one July corn future contract 15000 bushels) on the Chicago Board of Trade CBOT at the Current market price. What happens?
Solutions and discussions

As a first step in process, the broker passes your instructions on to a representative at the CBOT From there, the instructions are sent by the messenger to a trader on the floor of the exchange. This trader assesses the best price currently available and used hand signals to indicate to other traders that he or she is willing to buy one contract at that price if another trader indicates a willingness to take the other side of a position ((i.e. short one July contract). The deal will be done. If not, the trader representing you will hare to signal a willingness to trade at a higher price Eventually someone will be found to take the other side of the transaction Confirmation that your instruction have been carried out acid a notification of the price obtained are sent back to you though your broker
What types of traders are available in the trading pits?
There are two types of traders in the trading pits on the floor of an exchange. 1. Commission brokers Who execute trades for other people and earn Commissions and 2. Locals Who trade on their own account?
What types of orders may be passed to the commission brokers?
There are many different types of orders that can be passed on to a commission brokers (i) Market orders
The instructions to take a position at the current market price (ii) Limit order
195
This specifies a certain price and requests that the transaction be executed only if that price or a better price is obtained.
What happens in a Closing out positions?
Closing out a position involves entering into an opposite trade to the original one If an investor goes long one July cotton futures contract on march 6, he or she can close the position on April 20 by shorting one July cotton futures contract. If an investor shorts one July contract one march 6, he or she can close out the position on April 20 by going long one July contract. In each case, the investors total gain or loss reflects the change in the futures prices between March 6 and April 20. The vast majority of the futures contracts that are initiated are closed out in this way. The delivery of the underlying asset relatively rare. In spite of this, if is important to understand the delivery arrangements. This is because it is the possibility of final delivery that lies the futures price to the cash price.
10.2.2.1
The specification of the futures contract
When developing a new contract, an exchange must specify in some detail the exact nature of the agreement between the two parties In particular it must specify: (i) (ii) (iii) (iv) (v) (vi) The asset The contract size (i.e. exactly how much of the asset will be delivered under one contract) How the price paid will be determined How the prices will be quoted, Where delivery will be made and When delivery will be made Sometimes alternatives are specified for the asset that will be delivered and for the delivery arrangements. It is the party with short position (the party has agreed to sell) that chooses between these alternatives.
What about the asset?
196
When the asset is a Commodity there may be quite a variation in the quality of what is available in the market place. When specifying the asset, it is therefore important that the exchange stipulate the grade or grades of a commodity that are acceptable. The New York cotton exchange has specified The asset in its orange Juice futures as. Us Grade A, with Brix value of not less than 5y degrees, having a Brix value to and ratio of not less than 13 to 1 nor more that 19 to 1, with factors of colours and flavour each scoring 3y pants or higher and 19 for defects, with a minimum score of 94. The financial assets in future contract are generally well defined and unambiguous. For example there is no need to specify the grades of a Japanese yen.
Contract size
The contract size specifies the amount of the asset that has to be delivered under one contract. This is an important decision for the exchange. If the contract size is too large, many investors who wish to hedge relatively small exposure or who wish to take relatively small speculative positions will be unable to use the exchange. On the other hand, if the contract size is too small, trading may be expensive since there is a cost associated with each contract traded. The correct size for a contract; clearly depends on the likely user.
Delivery Arrangements
The place where delivery will be made must be specified by the exchange. This is particularly important for commodities where there may be significant transportation costs.
Price Quotes
The futures price is quoted in a way that is convenient and easy to understand. For example, crude oil futures prices of the New York Mercantile Exchange (NYMWX) are quoted in dollars per barred to two decimal places (i.e. to the nearest percent) Treasury bond and Treasury note futures prices of the Chicago Board of Trade are quoted in Dollars and 32rds of a dollar.
The minimum price movement that can occur in trading is consistent with the way in which the price is quoted. Thus, it is $0.01 (or 1 cent per barrel) for the oil future and one 32 nd of a dollar for the Treasury bond and Treasury note futures.
197
Daily Price Movement Limits
For most Contracts, daily price movement Limits are specified by the exchange for example, at the time of writing, the daily price movement Limit for oil futures is $1 If the price moves down by an amount equal to the daily price Limit, the contract is said to be Limit up. A Limit move is a move in either direction equal to the daily price limit. The purpose of daily price Limits is to prevent large price Movement occurring because of speculative excesses.
Position Limits
Position Limits are the maximum number of contracts that a speculator may hold. In the Chicago Mercantile Exchange random-length lumber contract, for example, the position Limit (at the time of working) is 1.000 contracts with no more than 300 in any one delivery month. Bonafide hedgers are not affected by position Limits.
The purpose of the Limits is to prevent speculation from exercising undue influence of the market.
The operation of margins
If two investors get in touch with each other directly and agree to trade an asset in the future for a certain price, there are obvious risks: (i) (ii) One of the investors may regret the deal and try to back out Alternatively, the investor simply may not have the financial resources to honour the agreement. One of the key roles of the exchange is to organize trading so that contracts definite are minimized this is where margins come in.
Marking to market what is it?
An investor who contacts his or her broker on any day to buy/sell a futures, contract will be required by the broker to deposit funds in what is termed as a margin account The amount that must be deposited at the time the contract is first entered into is known as the initial margin, this is determined by the broker. At the end of each trading day, margin account is adjusted to reflect the investors gain or loss. This is known as marking to market the account. A trade is first marked to market at the close of the day on which it takes place it is then marked to market at the closing of trading on each subsequent day.
198
If the delivery period is reached and delivery is made by the party with the short position, the price received is generally the futures price at the time the contract was last marked to market. Note that marking to market is not merely an arrangement between broker and client: When there is a decrease in the futures price 50 that the margin account of a investor with a long position is reduced say by $1000, the investors broker has to pay the exchange $1000 and the exchange passes the money on to the broker of an investor with a short position. Similarly when there is an increase in the future price, brokers for parties with short positions pay money to the exchange, and brokers for parties with long positions receive money from the exchange. The following illustration will give more details of the mechanism involved.
On Tuesday morning, an investor takes a long position in a Euro-futures that matures on Thursday morning, the agreed-upon price is $ 0.75 for euro 125,000. The following table provides the daily price movements up to the closing of trade on each day up to Thursday.
Table 10.2: Daily price movements Futures price

At the close of trading on Tuesday At the close of trading on Wednesday At the close of trading on Thursday $0.755 $0.752 $0.74
Required:
Detail the daily settlement marking to market process.
Solutions and discussions

The daily settlement with a futures contract is illustrated in the table below:
Time
Tuesday morning Tuesday close Wednesday Close Thursday
Action
Investor buys Euro futures contract that matures in two days. Price is $0.75 Futures price rises to $0.755. Position is marked to the market. Futures price drops to $ 0.752 Position is marked to the market. Futures price drops to $ 0.74. None
Cashflow
Investor receives: 125,000 x (0.755-0.75) = $ 625. Investor pays: 125,000 x (0.755-0.752) = $ 375 (i) Investor pays:

Close (i) (ii) Contract is marked to market Investor takes delivery of Euro 125,000.
199 125,000 x (0.752-0.74) = $ 1500 (ii) Investor pays: 125,000 x 0.74 = $ 92,500
Daily settlement reduces the default risk of futures contracts relative to forward contracts.
Every day, futures investors must pay over any losses or receive any gains from the days price movements. An insolvent investor with the profitable would be forced into default after only one day trading, rather than being allowed to build up huge losses that lead to one large default at the time the contract matures (as could occur with a forward contract).
Maintenance margin.
The investor is entitled to withdraw any balance in the margin account in excess of the initial margin. To ensure that the balance in the margin account never becomes negative, a maintenance margin, which is somewhat lower than the initial margin, is set. If the balance in the margin account falls below the maintenance margin, the investor receives a margin call and is required/requested to top up the margin account to the initial margin level within a very short period of time. The extra funds deposited are known as variation margin. If the investor does not provide the variation margin, the broker classes out the position by selling the contract. The Table below explains more in detail
The table below illustrates the operation of margin account for one possible sequence of futures prices in the case of investor considered here. The maintenance margin is assumed for the purpose of this example to be $ 1,500 per contract or $3,000 in total. On June 9, the balance in the margin account falls$340 below the maintenance margin level. This triggers a margin call from the broker for additional margin of $1,340. The table assumes that the investor does infract provide this margin by close of trading in June 10. On June 15, the balance in the margin account falls below the maintenance margin level and margin for $ 1,260 is sent out. The investor provides this margin by close of the trading on June 16. on the June 22,the investor decides to close out the position by shorting the two contracts. The futures price on that day is $ 392.30 and the investor has made a cumulative loss of $ 1,540. Note that the investor has excess margin on June 10, 17, 18 and 19. The table assumes that this is not withdrawn.
Table 10.3 Operation of Margins for a long position in two Gold Futures contracts
200
The initial margin is $2,000 per contract or $4,000 in total; the maintenance margin is $1,500 per contract or $3,000 in total. The contract is entered into on June 1 at $400 and closed out on June 22 at $392.30. The numbers in the second column except for the first and last number are the futures price at the close of trading. Futures Price (Dollars) 400.00 397.00 396.10 398.20 397.10 396.70 395.40 393.30 393.60 391.80 392.70 387.00 387.00 388.10 388.70 391.00 392.30 Daily Gain (Loss) (Dollars) (600) (180) 420 (220) (80) (260) (420) 60 (360) 180 (1,140) 0 220 120 460 260 Cumulative Gain (loss) (Dollars) (600) (780) (360) (580) (660) (920) (1,340) (1,280) (1,640) (1,460) (2,600) (2,600) (2,380) (2,260) (1,800) (1,540) Margin Acc Balance (Dollars) 4,000 3,400 3,220 3,640 3,420 3,340 3,080 2,660 4,060 3,700 3,880 2,740 4,000 4,220 4,340 4,800 5,060 Margin Call (Dollars)
Day June 1 June 2 June 3 June 4 June 5 June 8 June 9 June 10 June 11 June 12 June15 June 16 June 17 June18 June 19 June 22
1,340
1,260
Suppose that on day 1, a British pound June contract is purchased at the opening price of $1.4700/ and the contract is for 4 days with contract size of 62,500, the table below shows the futures price movement as provided for four days up to the close of the trading day on maturity. Day Status Opening or Settle Price 1 Openin $1.4700/ g 1 Close $1.4714/ 2 Close $1.4640/ 3 Close $1.4600/ 4 Close $1.4750/
Required:
Demonstrate how the marking to market process will be reflected in the margin account
Suggested solutions and discussions: In the morning of day 1:

A British pound June contract is purchased at the opening price of $1.4700/ and the contract size of 62,500 This means that one contract for 62,500 has a market price of $1.4700/ x 62,500 = $91,875
201
At the close of day 1:

The settle price, which is the price at the end of the day used for calculating settlement with the exchange, is $1.4714/; this is the markets expected future spot price for June at the end of day 1. At this price, the June pound contract to buy 62,500 is worth. $1.4714/ x 62,500 = $91,962.50 The purchase of the pound futures contract has earned the contract buyer $91,962.50 - $91,875 = $87.50 We assume this left in the purchasers margin account and added to the $2000 originally placed in the account. This is all shown in Table 10.3

On day 2 the June pound futures rate falls to $1.4640/. The contract is now worth $92.187.50 - $91,250 = $937.50 The margin account becomes $2937.50, and the contract owner can either withdraw the $937.50 or use it toward the margin on another futures contract. We assume it is withdrawn. All this is summarized in Table 10.3
Tutorial Note:
We have seen that with risk neutrality, the futures price equals the markets expected futures spot exchange rate. Therefore, the example indicates that futures can be thought of as daily bets on the value of the expected future spot exchange rate, where the bets are settled each day. In particular, on the other side of the margin adjustments to the futures buyers account described above and in Table 10.3 is the adjustments to the margin account of the seller of June pounds. When the buyers account is adjusted up, the sellers account is adjusted down the same amount. That is, what buyers gain, sellers lose, and vice versa. The two sides are taking daily bets against each other $1.4640/ x 62,500 = $91,500 Compared to the previous settle contract price of $91,962.50 there is a loss of $91,500 - $91,962.50 = -$462.50
When this is deducted from the margin account the total is $1625 ($2087.50 - $462.50). The margin remains above the maintenanceexpected future spot rate, theto be done. On day 3, because of a decline in the level of $1500 so nothing needs settle price on June pounds falls to $1.4600. The contract is now valued at $1.4600/ x 62,500 = $91,250 The loss form the previous day is $91,250 - $91,500 = -$250
202
This brings the margin account to $1625 - $250 = $1375, which is below the maintenance level of $1500. The contract buyer is asked to bring the account up to $200, requiring that at least $625 be put in the buyers account.

On day 4 the June futures rate settles at $1.4750, the contract is worth $1.4750/ x 62,500 = $92,187.50 This is a gain over the previous settlement of $91,250.0
Table 10.4.
Day Action
Settlements on a Pound Futures Contract

Opening or Settle Price $1.4700/ $1.4714/ $1.4640/ $1.4600/ $1.4750/ Contract Price Margin Adjustme nt 0 +$87.50 -$462.50 -$250.00 +$937.50 Margin Contributio n (+) or Withdrawal (-) +$2000.00 0 0 +$625.00 -$937.50 Margin Account
1 1 2 3 4
Opening Settle Settle Settle Settle
$91,875. 0 $91,962. 5 $91,500. 0 $91,250. 0 $92,187. 5
$2000.0 0 $2087.5 0 $1625.0 0 $2000.0 0 $2000.0 0
10.2.2.2
Convergence of futures price to Spot price
At the delivery month of a futures contract is approached the futures price converges to the spot price of the underlying asset. When the delivery period is reached, the futures price equals or is very close to the spot price
203
To show why this is so, suppose first that the futures price is above the spot price during the delivery period. This gives rise to a clear arbitrage opportunity for traders. 1. Short a futures contract 2. Buy lie asset 3. Make delivery This is certain to lead to a profit equal to the amount by which the futures price exceeds the spot price. As traders exploit this arbitrage opportunity, the futures price will fall. Suppose next that the futures price is below the spot price during the delivery period.
Companies interest in acquiring the asset will find if attractive to enter into a long futures contract and then wait for delivery to be made. As thy do this, the future price will tend to rise. Figures below illustrate the convergence of the futures price to the spot price.
Figure 10.2: Futures price above spot price

Futures price Spot price Time
Figure 10.3: Futures price below spot price

spot price futures price Time
10.2.3 10.2.3.1
Hedging using futures Long hedge vs. Short hedge:
What is a short hedge?
204
A company that knows it is due to sell an asset at a particular time in the future can hedge by taking a short futures position - this is known as a short hedge. If the price of the asset goes down, the company does not fare well on the sale of the asset, but makes a gain on the short futures position. If the price of the asset goes up, the company gains from the sale of the asset, but makes a loss on the futures position.
What is a long hedge?

Similarly, a company that knows it is due to buy an asset in the future can hedge by taking a long futures position-This is known as a long hedge. It is important to recognize that futures hedging does not necessarily improve the overall financial outcome. In fact, we can expect a futures hedge to make the outcome worse roughly 50% of the time. What the futures hedge does do is reduce risk by making the outcome more certain. There are number, of reasons why hedging using futures contracts works less that perfectly in practice: -
Operation of the futures Contracts: 1. Clearing house

The futures exchange uses a clearinghouse, which has as its main objective the guaranteeing of performance of the transactions carried out on the floor of the futures exchange.
205
Each transaction is reported to the clearinghouse by members so that both sides of the transaction can be matched and confirmed to the parties to the transaction. Once a transaction has been confirmed its performance is guaranteed by the clearinghouse. Each party to the transaction is then obligated to the clearinghouse to carry out the transaction; this has the effect of transferring the credit risk on the transaction to the clearinghouse.
2. Ticks
The exchange specifies the minimum price movements permitted for each type of contract. These minimum price movements are referred so as ticks in the case of LIFFE 50,000 long gilt interest rate futures contracts the tick size is 1/32 per 100 nominal value; each tick on this contract therefore has a value of 1/32 x (50,000/100) = 15,625 This value is used to calculate the profit or loss made on a futures contract.
The amount of profit would be calculated as follows Profits = (number of contracts) x (number of ticks by which the price has changed) x (tick value).
June 1993 $/DM futures contract is quoted at 0.6245 A us firm wishes to hedge an appreciation in the DM against the $ and plans to buy an appropriate number of $/DM currency futures (referred to as long hedge) The $/DM contracts are for DM 125.000 with a tick size of 0.01c (which is 0.01/100 =$0.001) Assuming that the firm buys one contract at a price of 0.6245 $/DM and the Dm strengthens against dollar to 0.6370 $/DM
Required:
Calculate the profit or loss of the currency future
Solution:
The firm can close out its position by selling the futures contract at 0.6370 $/DM resulting in a profit as follows: Tick value = 125.000 x 0.0001 =$12.50 Number of contracts = 1 Number of ticks by which the price has changed = {Change in Futures price / Tick size} (0.6370 0.6245) = 125 ticks

0.0001 The profit is therefore 1 contract x 125 ticks x12.50 = $1.562.50
206
This profit can be se-off against the loss the firm will make when it purchases the DM in the stock market. The prices in the futures market do not necessarily more exactly in line with the spot market. For this reason and the fact the firm may not be able to match the futures contract to the exact amount of exposure, currency futures will not necessarily provide a perfect hedge. Trading of currency futures contracts on LIFFE has been discontinued due to lack of demand; currency futures contracts are now handled mainly on the US markets.
3. Margins
We discussed about the operation of margin in earlier part of our discussion, the aim in this part is therefore to highlight key areas of consideration. The market price of the futures contract will change throughout the time between the date of someone buying or selling futures contracts and the delivery date (s), or more likely, the date on which the contract is closed out. There is a possibility that the price will move against the person/company buying or selling the contract resulting in a loss; in some cases the person/company may not be able to pay the loss thereby defaulting on the contract. This is a potential problem with futures contracts because, if there were no margins, contracts could initially be bought or sold without having to pay any consideration. The idea of having a margin is to minimize the possibility of defaults occurring on contracts and goes together with the fact that the clearinghouse takes on the credit risk of futures contracts. The margins system requires the person/company wishing to buy or sell a contract to deposit a specific amount of cash, referred to as an initial margin or deposit margin, with the clearinghouse of the exchange. The profit or loss on the position held by the person/ company is calculated at the end of each trading day and transferred to or from the margin account; this is referred to the margin account results in variation margin being received from or paid to the clearing house.
4. Gearing
207
Futures enable users to take a position in a financial instrument without having to incur the full cost of that instrument. The only cost is the initial margin, which is usually between 1% and 5% of the value of the underlying instrument. This has the effect of gearing up the returns on the transaction: enlarging gains if the market moves in the users favor and enlarging losses if the market moves against the user.
Hedging Efficiency
A perfect hedge is a hedge, which exactly cover the risk. A forward contract is a perfect hedge because it removes the risk of an movement in exchange rates of interest rates.
Why is it difficult to achieve a perfect hedge in a futures contract?

When using currently futures contract or interest rate futures contracts it is difficult to achieve a perfect hedge (or hedging efficiency of 100%) (i) (ii) One reason for this is the standard size of the futures contracts, which may not exactly fit the requirements of the firm. The other reason for this is referred to as basis risk; the risk that the price of the futures of the future contract may not move exactly in Line with the item being hedged (in the case of currency futures contract the exchange rate specified by the price of the currency futures contract will not necessarily move in Line with the exchange rate in the forward market).
There are 2 principal reasons for basis risk: 1. Difference in cash flow requirements With a forward contract there is normally no payment required when the contract is entered; with a futures contract it is necessary to deposit an initial margin 2. When the financial instrument that is being hedged is different from the financial instrument underlying the futures contract (referred to as cross hedging) For example, if hedging interest rates, which are based on the base rate with a futures, contract the price of which moves in line with LIBOR. The means that if a company is exposed to interest rate risk on 500.000 and it wished to totally remove the interest rate risk, it will need to take a position in futures contract for more or less than 500.000 The size of the future position to take can be determine by calculating the optimal hedge ratio
208
This is found by quantifying the relative volatility of the future price and the underlying interest rate
Optimal hedge ratio

The hedge ratio is the ratio of the amount of futures bought or sold to the amount of the underlying security being hedged. The optimum hedge ratio is the value of the ratio that minimizes the risk. You may expect the value of this ratio to be one, but because of the existence of basis risk it is likely to be other than 1.
Formula
Hedge ratio =
R Pi f Where; R = the Co efficient of correlation between the change in price of the underlying instrument over the period of the hedge and the change in price of the futures contract over the same period i = std deviation of the change in the price of the underlying instrument f = std deviation of the change in price of the future contract

Gaga Ltd wishes to hedge the interest rate risk on 5.000.000 2 year floating rate debt if i =0.06, of = 0.08 (the futures price is therefore more volatile then the price of the debt) on R=07
Required:
Optimal hedge ratio
Solution
Pi = 0.7 x 0.6 =0.525 f 0.08 Hence Gaga Ltd will need to take a position in futures contracts for: 5,000,000 x 0.525 = 2.625,000

10.2.4
209
Interest Rate Futures
Most LIFFE futures contract involve interest rates (interest rate futures), and these offer a means of hedging against the risk of interest rate movements. Such contracts are effectively a gamble on whether interest rates will rise or fall. Like other futures contracts, interest rate futures offer a way in which speculators can bet on market movements just as they offer others who are more risk-averse a way of hedging risks. Recall that a futures contract is an agreement to buy or sell a standard quantity of a particular financial instrument at a specified future date at an agreed price the price being determined by trading on the floor of futures exchange. For example, a company can contract to buy (or sell) 100,000 of a notional 30-year Treasury bond bearing an 8% coupon, in say, 6months time, at an agreed price. (a) The futures price is likely to vary with changes in interest rates, and this acts as a hedge against adverse interest rate movements. (b) The outlay to buy futures is much less than for buying the financial instrument itself, and so a company ca hedge large exposures of cash with a relatively small initial employment of cash. LIFFE provides a market for futures contracts in long-dated and short-dated gilt-edged stocks, American, German and Japanese government bonds, short-term sterling and Eurocurrency interest rates. The Chicago Mercantile Exchange (CME) and the Chicago Board of Trade (CBOT) are other important exchanges for the trading of interest rate futures rate futures. Interest rate futures are similar in effect to FRAs, except that the terms, the amounts and the periods are standardized.
10.2.4.1
Short-term interest rate futures
Most of the interest rate futures we shall encounter are for short term interest rates in sterling, Eurodollars and other Eurocurrency. These short-term interest rate futures contracts normally represent interest receivable or payable on notional lending or borrowing for a three month period beginning on a standard future date. The contract size depends on the currency in which the lending or borrowing takes place. For example, the 3-month sterling interest rate futures March contract represents the interest on notional lending or borrowing of 500,000 for three months, starting at the end of March. 500,000 is the contract size. As with all futures, a whole number of contracts must be dealt with. Note that the notional period of lending or borrowing starts when the contract expires, at the end of March. On LIFFE, futures contracts are available with maturity dates at the end of March, June, September and December. The 3-month Eurodollar interest rate futures contract is for notional lending or borrowing in US dollars. The contract size is $1million.
210
Note that with interest rate futures what we buy is the entitlement to interest receipts and what we sell is the promise to make interest payments. So when an investor buys one 3-month sterling contract he has the right to receive interest for three months in pounds. When he sells a 3-month sterling contract he incurs an obligation to make interest payments for three months. The price at which a short-term interest rate future can be bought or sold is determined by the three-month interest rate r%, which the investor contracts for. It is calculated as (100-r). For example, an investor who buys one 3-month sterling interest rate futures March contract at the price of 92.00 is notionally contracting to lend 500,000, receiving interest for three months at 8% (because 100-8=92). Note that the interest rate must be stated as a percentage, not a decimal. If, over the next week, the futures price increases to 92.20, this implies that interest rates at the end of March are now expected to be lower at 7.8% (because 100-7.8=92.20).
How can an investor close out his position.

The investor can close out his position by selling one 3-month sterling interest rate futures March contract at 92.20. This means that he is notionally contracting to borrow 500,000 for 3 months at 7.8% and lending it at 8%. The value of the gain is 0.2% x 3/12 x 500,000 = 250. The gain on closing out can be calculated directly from the prices at which the future was bought and on closing out can be calculated directly from the prices at which the future was bought and sold: Sell at 92.20 Buy at 92.00 Gain 0.20 0.2% x 3/12 x 500,000 = 250 As with other futures, the gain is normally calculated by means of ticks. Remember that a tick is the smallest measured movement in the price of a futures contract, which in this case is 0.01, which represents 0.01% interest or 3 months on 500,000. So the value of one tick on the 3-month sterling contract is 0.01% x 3/12 x 500,000 = 12.50. The value of the investors gain in the example above can be computed as 20ticks x 12.50 x 1 contract = 250. The tick values of other short-term interest rate futures contracts are shown in the table above. For example the contract size of the 3 month Eurodollar is $1000,000. The tick value is 0.01% x 3/12 x $1,000,000 = $25. Note from the table that the tick values of interest rate futures are always in the same currency as the contract itself. Contrast this with currency futures, where the tick values were always in US dollars.
211
Margins
Initial margins and variation margins work in exactly the same way as with currency futures. In order to buy or sell one 3- month sterling futures contract, the investor does not have to advance the full 500,000, but only an initial margin of 300. Similarly the 3-month Eurodollar contract has an initial margin of $500. Variation margin represents the change in price of the contract from day to day. Long-term interest rate futures are priced differently from the short-term interest rate futures described above. They represent the present value of interest to be received or paid over a long period; in other words they represent the value of a notional long-dated fixed interest government bond. Pricing for long-term bond futures is as a percentage of par value, similarly to the pricing of bonds themselves. (a) In the case of US Treasury bond futures and Notional UK gilt futures, prices are quoted in 32nds of each full percentage point of price. The number of 32nds is shown as a number following a hyphen. For example, 91-23 denotes a price of 9123/32 per 100nominal value and 9116 denotes a price of 91 per 100 nominal value. For other types of bond future, decimal pricing is used, so that if Italian government bond futures are quoted at 92.75, this indicates a price of 92 per 100 nominal value.
(b)
Notional UK gilts have a nominal interest rate of 9%. If the price is quoted as 113 16, this shows that the notional bond has a value of 113.5. The long-term yield implied is therefore approximately 9% x 100/113.5 = 7.93% (although the accurate figure needs to take into account the period to maturity of the underlying gilt).
Illustrative Example 12: Futures Price Movements

September long gilts sterling futures fell in price on a particular day from 99-9 to 9827. Private plc has sold September futures, having a short position of 10 contracts.
Required
Calculate the change in value of the contract on the day concerned.
Solution
The fall in price represents 14 ticks (999/32 9827/32 = 14/32 and the tick size is 1/32 of 1%).The value of one tick for long gilts sterling futures is 15.625( 50,000/100 x 32). Each contract has fallen in value by 15.625 x 14 = 218.75. For Private plc, which has sold 10 contracts, the days price movement represents a profit of 218.75 x 10 = 2, 187.50.
212
The following futures price movements were observed during a week in October Contract December short sterling December US Treasury bonds December Japanese government bond Price at start of week 90.40 92.16 93.80 Price at end of week 91.02 92.06 94.25
Hawthorn plc has the following positions in these contracts: (a) (b) (c) A short position (seller) of ten December short sterling contracts A long position (buyer) of six December US Treasury bonds contracts A long position of eight December Japanese government bonds contracts Notional amount Of deposit 500,000 $100,000 Y100, 000
Interest rate futures 3-Month (short sterling) US Treasury bonds Japanese government bond Tick size 0.01 1/32 of 1 0.01 Tick value 12.50 $31.25 Y10, 000
Required:
Calculate the profit or loss to the company on the futures contracts.
Solutions
Short sterling Increase in price (91.02 90.40 = 0.62) Value per tick Increase in value of one contract (62 x 12.50) 62 ticks 12.50 775
The company is a seller of ten contracts and would lose 7,750 (775 x 10) US Treasury bond futures Fall in price (9216/32 926/32) = 10/32 Value per tick Fall in value of one contract (10 x $31.25) 10 ticks $31,25 $312.50
The company is a buyer of six contracts and would lose $1,875 ($312.50 x 6) Japanese government bonds Increase in price (94.25 93.80 = 0.45) 45 ticks Value per tick Y10, 000 Increase in value of one contract (45 x Y10, Y450, 000 000)
213
The company is a buyer of eight contracts and would gain Y3, 600,000 (Y450, 000 x 8)
Hedging using interest rate futures The hedges illustrated here are initially concerned with short term lending or borrowing for periods of up to about one year. To hedge borrowing
If a corporate treasurer knows that his company needs to borrow at some future date but is concerned about the risk of interest rates rising before the start date of the borrowing, he can set up a hedge using interest rate futures which will produce the same sort of result as a forward rate agreement with a bank. In the language of interest rate futures, borrowing equals selling, so the treasurer must sell interest rate futures now and buy them on the date that actual borrowing starts. If interest rates rise over the period, the futures price will fall. The futures will therefore be sold at a higher price than they are bought for and the resulting gain will compensate for the increase in interest rates. As with all other futures, however, the company cannot take advantage of falling interest rates because the futures hedge will produce a compensating loss.
Illustrative Example Transaction
13:
Hedge
of
borrowing
In three months time, at the beginning of May, U & I plc will need to borrow 10 million for a three-month period. The company can currently borrow at 9% per annum but the treasurer is concerned that interest rates will rise before May, The 3-month sterling interest rate futures June contract is currently trading at 93.34.
Required
(a) (b) Show how a futures hedge can be set up. Illustrate the result of the hedge if by May: (i) Interest rates have risen by 1% and the futures price has fallen by 1.00 (ii) Interest rates have fallen by 0.5% and the futures price has risen by 0.48
Solution
(a) 10,000,000 borrowing for three months is 10,000,000/500,000 contracts = 20 contracts. The futures hedge is set up by selling 20 3-month sterling June contracts at the price of 93.34. The target interest payable at todays interest rate of 9% per annum is 10 million x 9% x 3/12 = 225,000.
(b)
214
The actual results under the two interest rate scenarios in May are as follows. (i) 10.00% 250,00 0 (ii) 8.50% 212,500
Scenario Company borrows at Actual interest paid Result of futures hedge: Sold 20 contracts at Bought 20 contracts at Gain/(loss) in ticks Total gain /(loss) on 20 contracts at 12.50 per tick Net payment
93.34 92.34 100 25,000 225,00 0
93.34 93.82 (48) (12,000) 224,500
In Scenario (i), the actual interest less the futures gain gives a total exactly on target. The hedge efficiency is 100%. In Scenario (ii), the actual interest is a gain of 12,500 on target and the future gives a loss of 12,000. The hedge efficiency is caused entirely by basis risk. The interest saving was 0.5% and the futures loss was 0.48% giving hedge efficiency of 0.5/0.48 = 104.2%.
To hedge lending
In the language of interest rate futures, lending equals buying. The treasurer hedges against the possibility of falling interest rates by buying futures now and selling futures on the date that the actual lending starts. The calculation proceeds in a similar way to the example above
Illustrative 13 Transaction
Example:
Hedge
of
lending
Buster plc will have a surplus of 2 million US dollars for three months starting in August. The cash will be placed on fixed interest deposit, for which the current rate of interest is 5% pa.
Required
How can the deposit income be hedged using futures contracts? The September 3month Eurodollar futures contract is currently trading at 94.00.
Chapter 10 Forward and Futures Contracts Solution
215
The target interest to be earned is $2 million x 5% x 3/12 = $25,000. The 3-month Eurodollar contract size is $1 million and the tick value is $25. To hedge lending; buy two 3-month Eurodollar September futures contracts now and sell two contracts in August. Suppose that by August, interest rates have fallen by 1%. The $2 million is deposited at 4% for three months, yielding $20,000, a shortfall on target o $5,000. If the futures market has also moved by 1%, the contract price will have risen to 95.00, giving a gain of 100 ticks. The gain from selling 2 contracts at the higher price is 2x 100 ticks x 100 ticks x $25 = $5,000. This compensates for the shortfall in actual interest.
Maturity mismatch
Maturity mismatch occurs if the actual period of lending or borrowing does not match the notional period of the futures contract (three months). The number of futures contracts used has to be adjusted accordingly. Since fixed interest is involved, the number of contracts is adjusted in proportion to he time period of the actual loan or deposit compared with three months. For example, if the period of borrowing is six months the number of contracts is doubled. This leads to the following formula. of futures = Amount of actual loan or deposit X time period Futures contract size x 3 months.
Number contracts
Illustrative Example 14: Maturity Mismatch (1)

On 5 June, a corporate treasurer decides to hedge a short-term deficit of 17 million Swiss francs, which is predicted to arise for 2 months from 4 October to 3 December. Three month Euro Swiss franc futures, December contract, are trading at 98.15. The contract size is SFr 1 million.
Required
Show the action taken.
Solution
Number of futures contracts = SFr 17 million x 2 months / SFr 1million x 3 months = 11.33 contracts, rounded to 11.
Illustrative Example 14: Maturity Mismatch (2)
216
In three months time (June), Health plc will need to borrow 10 million for a six-month period. Current interest rates for such a loan are 8% per annum. The company treasurer expects interest rates to rise by 2% over the ext three months. LIFFE Three months sterling futures 500,000 points of 100% are available, with June futures priced at 92.50. Tax, margin requirements and the time value of money can be ignored.
Required
What is the effect of using the futures market if the interest rate rises by 2% and the futures price moves by, say, 1.8%?
Solution
Points of 100% indicate that the tick size on a three-month contract is 500,000 x 0.01% x 3/12 = 12.50. The companys anticipated additional interest costs, which need to be matched by the expected gain on the futures, are: 10 million x 2% x 6/12 = 100,000 Our next task now is to calculate the break- even number of contracts that will enable the company offset the additional interest of 100,000, we can do this as follows: A 2% movement in the futures price would represent 200 ticks. The gain on a single contract would be 200 x 12.50 = 2,500. The company needs 40 futures contracts to make the gain of 100,000 required, assuming that the futures price moves in line with interest rates. The futures market gain will be 40 x 180 ticks x 12.50 = 90,000, not quite enough to offset fully the 100,000 additional interest costs. The hedge efficiency is 90,000/100,000 = 90%
Use of short-term interest rate futures to hedge interest rates in a long-term floating rate loan.
So far the
above examples have concentrated on short-term lending and borrowing, but 3- month interest rate futures can also be used to hedge interest on longer term floating rate loans. Typically these loans are subject to a rollover every three months. In other words, every three months the loan interest rate is reviewed and set for the next three - months. Illustrative Example 15: Long-Term Floating Rate Loan
217
Assenga Ltd a UK company based in Tanzania has a 5-year 5 million floating rate loan at an interest rate of LIBOR + 2%. (LIBOR = London Inter Bank Offered Rate). Interest is reviewed every three months on 1 February, May, August and November. It is now 25 November and the treasurer is worried that sterling interest rates are about to rise. 3-month sterling interest rate futures (contract size 500,000) are available with March and June maturity dates.
Required:
Show how the next two-rollover periods can be hedged (no computations required)
Solution
The floating rate loan is regarded as a series of 3-month short-term loans and the treasurer hedges the interest in 3-month blocks. The next two-rollover periods are 1 February to 30 April and 1 May to 31 July. The interest rate for the three month periods will be set on 1 February ad 1 May. For the 1 February rollover date, March or June futures can be used but for the May rollover date June futures must be used. The value of the 5 million loan represents 10 contracts. The most likely action taken by the treasurer is: Now: Sell 10 March futures contracts and 10 June futures contracts. 1 Feb: Buy 10 March futures contracts. 1 May: Buy 10 June futures contracts.
Use of interest rate futures

The standardized nature of interest rate futures is a limitation on their use by the corporate treasurer as a means of hedging, because they cannot always be matched with specific interest rate exposures. Futures contacts are frequently use by banks and other financial institutions as a means of hedging their portfolios: such institutions are often not concerned with achieving an exact match with their underlying exposure. The seller of a futures contract does not have to own the underlying instrument, but may need to deliver it on the contracts delivery date if the buyer requires it. Most, but not all, interest rate contracts are settled for cash rather than by delivery of the underling instrument. Interest rate futures offer a means of speculation for some investors, because there is no requirement that buyers and sellers should actually be lenders and borrowers (respectively) of the nominal amounts of the contracts. A relatively small investment can lead to substantial gains, or alternatively to substantial losses. The speculator is in effect betting on future interest rate movements.
Basis risk
The concept of hedge efficiency was introduced earlier. Remember that there are two
218
Reasons why it is often not possible to achieve a perfect (100%) hedge with currency futures or interest rate futures, as follows: (a) (b) The fact that futures are available only in certain standard sizes means that the contracts may not fit exactly the companys needs. There is basis risk arising from the fact that the price of the futures contract may not move as expected in relation to the value of the instrument, which is being hedged. What then are the reasons for the basis risk?
There are two main reasons for this basis risk. 1. Cash flows requirements may differ, altering the relative values of the underlying financial instrument and the derivative futures contract. This is because usually no payment is required when a forward contract is entered into, while an initial margin must be deposited for a futures contract. The financial instrument, which the firm is seeking to hedge, may be different from the financial instrument, which underlies the futures contract. For example, a firm may wish to hedge interest rates, which are linked to bank base interest rates using a futures contract, which is based on the London InterBank Offered Rate (LIBOR). This type of hedge is called cross hedging, and there will be basis risk because LIBOR will not always move exactly in line with bank base interest rates. How do we calculate basis risk? The basis risk can be calculated as the difference between the futures price and current price (cash market price) of the underlying security.
2.
the
Illustrative Example 16: Basis and Basis Risk

Supposing a three-month LIBOR (the London Inter-Bank Offered Rate) is 7% and the September price of the three-month sterling future is 92.70 now (at the end of March, say)
Required:
Calculate the basis or the basis points Libor (100-7) Futures 93.00 92.70 0.30% Or 30 basis points
If a firm takes a position in the futures contract with a view to closing out the contract before its maturity, there is still likely to be basis, and the firm can only estimate what effect his will have on the hedge. Basis risk refers to the problem that the basis may result in an imperfect hedge. The basis will be zero at the maturity date of the contract.
219
In the above example, suppose that the future is being used to edge a borrowing commitment, which begins in 5 months time, one month before the maturity date. We may estimate the expected basis by assuming that it reduces steadily to zero. 30x1/6 = 5 basis points. The expected movement in basis will be disadvantageous to the company. If interest rates rise by 1% (to the equivalent of 92.00), then with five basis points, the futures price is expected to move to (92.00 0.05)= 91.95. The loss of 1% in the cash market is offset by a (92.70 91.95) = 0.75% gain in the futures market, resulting in an imperfect hedge. However, there is no guarantee that the basis will turn out to be the figure estimated: movement in the yield curve could change the basis.
Hedge ratio
The hedge ratio has been explained earlier on as the ratio of the amount of the futures contracts bought or sold to the amount of the underlying financial instrument being hedged. For example, if a company is exposed to interest rate risk on a loan of TShs 210,000,000 and it takes a position in futures contracts for TShs 200,000,000. The hedge ratio will be calculated as follows: 200,000,000 / 210,000,000 = 95.2%
Optimal hedge ratio

The optimal hedge ratio is given by the formula: Px i f Where P = i= f= The coefficient of correlation between the change in price of the underlying Instrument and the change in price of the futures contract, The standard deviation of the change in the price of the underlying instrument The standard deviation of the change in the price of the futures contract
As you can probably appreciate, establishing values for the variables p, i and f is more of a problem than calculating the optimal hedge ratio using the formula.
Illustrative Example 17: Optimal hedge ratio

Moshi Ltd a UK company based in Tanzania wishes to hedge the interest rate risk on a 1 year floating rate loan of 2,000,000. The futures price is more volatile than the price of the debt, such that i = 0.08 and f = 0.10. P = 0.6.
220
Required:
What is the optimal hedge ratio?
Solution
Optimal hedge ratio = P ( i/ f) = 0.6 x 0.08/0.10 = 0.48 It follows that Moshi Ltd should take a position in interest rate futures for: 2,000,000 x 0.48 = 960,000
Gaga Plc has a 40 million Eurodollar loan with a 6 monthly roll over which is next due on 1 June. On 5 April when interest rate is 8%, 2 months before the roll over is due, the finance director of Gaga Plc is worried that interest rates will increase before roll over occurs. The appropriate interest rate futures contract to use is referred to on LIFFE as a short Eurodollar interest rate contract. The standard size of these contracts, which are 3month contracts, is 1 million. Prices are quoted at 100 minus the annualized yield in basis points and the tick size is 0.01% with a value of 0.01/100 x 3/12 x 1,000,000 = 25. Initial margin requirement is 750 per contract. To hedge the risk of interest rate increases the finance director sells an appropriate number of these contracts when the market price was 91.75 (reflecting a yield of 100 91.75 = 8.25%). On 1 June the interest rate on the 6 month Eurodollar loan had increased to 13% and the price of the 3-month Eurodollar interest rate contracts had fallen to 86.50. to close out his position the finance director buys the appropriate number of contract on 1 June. The financial effect of these transactions is as follows: (a) Effect of the futures contracts It is first necessary to determine the number of contract needed to cover the exposure: the number of contracts appears to be 40,000,000/1,000,000 = 40 contract but these only hedge the exposure for 3 months. Since the Eurodollar loan is for 6 months a total of 2 x 40 = 80 contracts are needed.
221
On 5 April: Sell 80 contracts at 91.75: Initial margin: 80 x 750 On June 1st: Return of initial margin Future gain received: 91.75 86.50 = 525 ticks at TShs 25 x 80 contracts =0.01 Net gain (b) Increase in interest costs relating to the loan (0.13 0.08) x 6/12 x 40,000 = 1,000
Cash flows 000 Nil (60) 60 1,050 1,050
In this case the finance directors hedge has been 1.050/1,000 = 105% successful or efficient. NB the gain does not occur only on 1 June; the moving to market system means it can be continually taken as it occurs.
More about Basis risk If thinking of using rate futures contracts it is important to be aware of basis risk. The basis is the difference between the spot price of the security to be hedged and the price of the futures contract used. The basis risk is the possible change in the life of the contract. Basis risk arises when the financial instrument that is being hedged is different from the financial instrument underlying the futures contract. If the basis remains unchanged at the end of the position a perfect hedge will result, but this is rate. The methods of price quotation for the three-month contracts are 100 less the rate of interest. On 12 March 1993 the LIFFE three-month sterling futures contracts had the following prices: Mar Jun Sept Dec 94.10 94.51 94.72 94.69
These prices reflect the level of short-term interest rates and the view of the market at that time that short-term interest rates were expected to fall. The rate implied by these prices fall from (100 94.10) 5.9% to (100 94.69) 5.31%. if a treasurer is concerned that interest rates earned on a companys investments will fall and wishes to hedge the risk of that fall he/she can only do so to the extent that a fall in interest rates is not built into the futures prices.
222
For long term interest rate futures contracts prices are quoted for 100 units nominal value. The tick size for the 9% Notional British Gilt is TShs 11/32. This is the price movement per 100 nominal. Hence to find the tick value it is necessary to Notional British Gilt contracts had the following prices: Mar Jun 105.21 106.16
The March price is TShs 105 21/32 per TShs 100 nominal which implies an interest rate of approximately 9/(105 21/32) = 8.52% (an accurate estimate of the interest rates needs to take account of the yield to maturity of the underlying gilt). The June price implies an interest rate of approximately 9/(106 16/32) = 8.45%. these interest rates reflect the level of long term and suggest that the market expects rates to fall.
10.2.5
Hedging With Commodity Futures
Hedging as pointed out earlier involves taking on one risk to offset another. We will explain shortly how to set up a hedge, but first we will give some examples and describe some tools that are specially designed for hedging. We start with the oldest actively traded derivative instruments, commodity futures contracts. Futures were originally developed for agricultural and other commodities. For example, suppose that a wheat farmer expects to have 100,000 bushels of wheat to sell next September. If he is worried that the price may decline in the interim, he can hedge by selling 100,000 bushels of September wheat futures. In this case he agrees to deliver 100,000 bushels of wheat in September at a price that is set today. Do not confuse this futures contract with an option, in which the holder has a choice whether to make delivery; the farmers futures contract is a firm promise to deliver wheat. A miller is in the opposite position. She needs to buy wheat after the harvest. If she would like to fix the price of this wheat ahead of time, she can do so by buying wheat futures. In other words, she agrees to take delivery of wheat in the future at a price that is fixed today. The miller also does not have an option; if she holds the contract to maturity, she is obliged to take delivery. Both the farmer and miller have less risk than before. The farmer has hedged risk by selling wheat futures; this is termed a short hedge. The miller has hedged risk by buying wheat futures; this known as a long hedge.
223
The price of wheat for immediate delivery is known as the spot price. When the farmer sells wheat futures, the price that he agrees to take for his wheat may be very different from the spot price. But as the date for delivery approaches, a futures contract becomes more and more like a spot contract and the price of the future snuggles up to the spot price. The farmer may decide to wait until his futures contract matures and then deliver wheat to the buyer. In practice, such delivery is very rate, for it is more convenient for the farmer to buy back the wheat futures just before maturity. If he is properly hedged, any loss on his wheat crop will be exactly offset by the profit on his sale and subsequent repurchase of wheat futures.
Notice that our farmer and miller are not the only businesses that can hedge risk with commodity futures. The lumber company and the builder can hedge against changes in lumber prices, the copper producer and the cable manufacturer can hedge against changes in copper prices, and the oil producer and the trucker can hedge against changes in gasoline prices.
For many firms the wide fluctuations in interest rates and exchange rates have become at least as important a source of risk as changes in commodity prices. Financial futures are similar to commodity futures, but instead of placing an order to buy or sell a commodity at a future date, you place an order to buy or sell a financial asset at a future date. You can trade futures on the Thailand stock market index, the South African rand, Finnish government bonds, and many other financial assets. Financial futures have been a remarkably successful innovation. They were in vented in 1972; within a few years, trading in financial futures significantly exceeded trading in commodity futures.
An overview of the Mechanics of Commodity Futures Trading When you buy or sell a futures contract, the price is fixed today but payment is not made until later. You will, however, be asked to put up margin in the form of either cash or Treasury bills to demonstrate that you have the money to honor your side of the bargain. As long as you earn interest on the margined securities, there is no cost to you.
In addition, futures contracts are marked to market. This means that each day any profits or losses on the contract are calculated; you pay the exchange any losses and receive any profits. For example, suppose that our farmer agreed to deliver 100,000 bushels of wheat at $2.80 a bushel. The next day the price of wheat futures declines to $2.75 a bushel. The farmer now has a profit on his sale of 100,000 x $.05 = $5,000.
224
The exchanges clearing house therefore pays this $5,000 to the farmer. You can think of the farmer as closing out his position every day and then opening up a new poison. Thus after the first day the farmer has realized a profit of $5,000 on his trade and now has an obligation to deliver wheat for $2.75 a bushel. The $.05 that the farmer has already been paid plus the $2.75 that remains to be paid equals the $2.80 selling price at which the farmer originally agreed to deliver wheat. Of course, our miller is in the opposite position. The fall in the futures price leaves her with a loss of $.05 a bushel. She must, therefore, pay over this loss to the exchanges clearinghouse. In effect, the miller closes out her initial purchase at a $.05 loss and opens a new contract to take delivery at $2.75 a bushel.
Spot and Futures Prices Financial Futures If you want to buy a security, you have a choice. You can buy it for immediate delivery at the spot price. Alternatively, you can place an order for later delivery; in this case you buy at the futures price. When you buy a financial future, you end up with exactly the same security that you would have if you bought in the spot market. However, there are two differences. First, you dont pay for the security up front, and so you can earn interest on its purchase price. Second, you miss out on any dividend or interest that is paid in the interim. This tells us something about the relationship between the spot and future pieces: Futures price/(1+rf) payments forgone
t
= spot/price PV (dividends or interest
Here rf is the t-period risk-free interest rate. An example will show how and why this formula works. Illustrative Example 19: Stock Index Futures
225
Suppose six-month stock index futures trade at 1,205 when the index is 1,190. The six-month interest rate is 4 percent, and the average dividend yield of stocks in the index is 1.6 percent per year. Required: Are these numbers consistent? Suppose you buy the futures contract and set aside the money to exercise it. At a 4 percent annual rate, youll earn about 2 percent interest over the next six months. Thus, you invest Furniture price/(1+rf) t = 1,205/1.02 = 1,181 You get what you pay for: Spot and Futures Prices Commodities
The difference between buying commodities today and buying commodity futures is more complicated. First, because payment is again delayed, the buyer of the future earns interest on her money. Second, she does not need to store the commodities and, therefore, saves warehouse costs, wastage, and so on. On the other hand, the futures contract gives no convenience yield, which is the value of being able to get your hands on the real thing. The manager of a supermarket cant stock the shelves with orange juice futures if he runs out of inventory at 1 P.M. on a Saturday. All this means that for commodities, Futures price/(1+rf) t = spot price + PV (storage coats) - PV (convenience yield) No one would be willing to hold the futures contract at a higher futures price or to hold the commodity at a lower futures price. Its interesting to compare the formulas for futures prices of commodities to the formulas for securities. PV (convenience yield) plays the same role as PV (dividends or interest payments forgone). But financial assets cost nothing to store, so PV (storage costs) does not appear in the formula for financial futures. You cant observe PV (convenience yield) or PV (storage) separately, but you can infer the difference between them by comparing the spot price to the discounted futures price. This difference-that is, convenience yield less storage cost-is called net convenience yield.
Here is an example using quotes for august 2001.
226
At august 2004, the spot price of coffee was about 51 cents per pound. The futures price for March 2005 was 58.7 cents. Of course, if you bought and held the futures, you would not pay until March. The present value of this outlay is 57.4 cents, using a one-year interest rate of 4 percents. So PV (net convenience yield) is negative at 6.4 cents a pound: PV (net convenience yield) = spot price futures price/1+rf =51-57.4=-6.4 cents Sometimes the net convenience yield is expressed as a percentage of the spot price, in this case as 6.4/51 = -.125, or 12.5 percent. Coffee in 2001 was in ample supply and evidently; roasters had no worries that they would run short in the months ahead. There is one further complication that we should note. There are some commodities that cannot be stored at all. You cant store electricity, for example. As a result, electricity supplied in, say, six-months time is effectively a different commodity from electricity available now, and there is no simple link between todays price and that of a futures contract to buy or sell at he end of six months. Of course, generators and consumers will have their own views of what the spot price is likely to be when those six months have elapsed, and they may be more or less eager to fix today the price at which they buy or sell.
10.2.6
What is a Currency Future?
Currency futures are standardized contracts that trade like conventional commodity futures on the floor of a futures exchange. Orders to buy or sell a fixed amount of foreign currency are received by brokers or exchange members. These orders, form companies individuals and even market making commercial banks, are communicated to the floor of the futures exchange. At the exchange, long positions (orders to buy a currency0 are matched with short positions (orders to sell). The exchange, or more precisely, its clearing corporation, guarantees both sides of each two sided contract, that is, the contract to buy and the contract to sell. The willingness to buy versus the willingness to sell moves futures process up and down to maintain a balance between the numbers of buy and sell orders. The marketclearing price is reached in the vibrant, somewhat chaotic-appearing trading pit of the
227
futures exchange. Currency futures began trading in the International Money Market (IMM) of the Chicago Mercantile Exchange in 1972. Since then many other markets have opened, including the COMEX commodities exchange in New York, the Chicago Board of Trade, and the London International Financial Futures Exchange (LIFFE). In order for a market to be made in currency futures contracts, it is necessary to have only a few value dates. At the Chicago IMM, there are four value dates of contracts.: the third Wednesday in the months March, June, September, and December. In the rare event that contracts are held to maturity, delivery of the underlying foreign currency occurs 2 business days after the contract matures to allow for the normal 2day delivery of spot currency. Contracts are traded in specific sizes - 62,500, Can $100,000, and so on. This keeps the contracts sufficiently homogeneous and few in varieties that there is enough depth for a market to be made. The currencies that are traded, along with their contract sizes, are shown in Figure 10.1
In the IMM of the Chicago Mercantile exchange, futures prices of foreign currencies are quoted as U.S. dollar equivalent that is as U.S. Dollars per unit of foreign currency. On the other hand, forward rates, except for the British pound, are quoted in European terms, that is, as foreign currency per U.S. dollar. In the case of the Japanese yen the first two digit of the U.S. dollar price of the yen are omitted. This is the meaning of the (.00) in the heading above the yen futures prices. For example, the contract maturing in March has a settle price of $0.009593 per Japanese yen. The prices in Figure 10.1 are U.S. dollar prices per unit of foreign currency. To convert these per-unit prices into futures contract prices it is necessary to multiply the prices in the table by the contract amount. For example, the Japanese yen contract is for 12.5 million. With the settle price per yen for March delivery of $0.009593, the price of one Japanese yen March contract is
$0.009593/ x 12,500,000 = $119,912.50 As with forward exchange contracts, if we assume risk neutrality, the per-unit price of futures equals the markets expected future spot rate of the foreign currency. Otherwise, if for example, the expected March 1995 spot rate of the Canadian dollar were above $0.7463/Can$, speculators would buy Canadian dollar futures, pushing the futures price up to expected future spot level. Similarly, if the expected March 1995 spot rate were below the futures price of $0.7463/Can$, speculators would sell Canadian dollar futures until they had forced the future price back to the expected futures spot rate. It follows that it is changes in the markets expected future spot exchange rate that drive futures contract prices up and down.
228
Both buyers and sellers of currency futures must post a margin and pay a transaction fee. The margin is posted in margin account at a brokerage house, which in turn posts margin at the clearing corporation of the exchange. The clearing corporation, in turn, pairs buy and sell orders, that is, matches each buy order with a sell order, and that is, matches each buy order with a sell order. As we have said, all buy and sell orders are guaranteed by the clearing corporation. Margins must be supplemented by contract holders and brokerage houses if the amount in a margin account falls below a certain level, called the maintenance level. For example, the IMMs required minimum margin on sterling (British pounds) is currently $2000 per contract, and its maintenance level is $1500. This means that if the market value of the contract valued at the settle price falls more than $500, the full amount of the decline in value must be added to the clients and the brokers margin accounts. Declines in contract values which are small enough to leave more than $1500 of equity do not require action. Increases in the values of contracts are added to margin accounts and can be withdrawn. Margin adjustment is done on a daily basis and is called marking to market.
10.2.7
Rollover of futures contracts
If the delivery dates of the available futures contracts are prior to the date into which a hedge is needed a firm may roll the hedge forward. This is achieved by closing out one futures contract and simultaneously taking the same position in another futures contract with a later delivery date. There is a risk that the price at which the future contract is closed out is not the same as the price of the new future contract.
Lelo Ltd, a company incorporated in the list, import goods from a company in German and pays for them in Euro Lelo Ltd is due to pay Euro 260,000 in 30dyas time and wished to hedge the risk that the will strengthen against the US $using currency futures. The spot rate today is 0.6221 $/ and the Euro futures contract rate is 0.6247 $/. The company buys two Euro 125,000 contracts. In 30 days time the spot rate is 0.6351 $/Euro and the futures price has moved to 0.6367 $/DM Note: The /$ Currency futures contract size is given as 62,500
Required
Evaluate the effect of the hedge
Solution:
(a) Effect of the movement in the spot rate; This will result in a higher $ cost of the Payment to the supplier;

(0.6351 0.6221) x 260,000 = $3.380 (b) Profit on the currency futures contract: The futures price has moved by (0.6367 0.6247) /0.0001 = 120 ticks Total profit is therefore; 2 contract x 120 ticks $ (125,000 x 0.0001) = $ 3,000
229
The currency futures contracts have not provided a perfect hedge (that is have not full covered the loss of $ 3.380) for 2 reasons
1. The futures contract did not exactly match the amount of currency exposed. This resulted into an uncovered loss of (0.6351 0.6221) x (260.000 250.000) = $ 130 2. The price of the futures market did not move as much as the spot rate. the spot rate moved by (0.6351 0.6221) =$0.13 whereas the futures price moved by (0.6367 0.6247) =$ 0.12. Hence an uncovered loss of (0.013 0.012) x 250.000 =$250 occurred making a total loss of $ 3.380 -$3.000 = $380. A further exposure could arise if the rate at which the currency is required id different from the date of the currency future contract.
Examination Style Questions: Chapter 10

Question 1: Stringer PLC is due to receive $50,000 in 1 years time. The company can borrow $ at a
rate of 12% per annum.
Question 2:
(a)
Outline the reasons why exchange rate forecasting is needed.

(b)
230
A German Company exports goods to the USA and invoices its customer for US$1,522,800 payable in August. It is now June. In the foreign exchange market, the following quotations are made: Spot: August Forward: US$/Euro 1.4070 1.4090 1.4030 1.4150 (A one Euro
September Euro futures contracts are priced at US$ 1.4100. Futures contract represents Euro 108,000)
Require d:
Set up the hedge position and calculate the hedge efficiency if in August the US$/Euro spot rate is US$1.4150 1.4170 and the September Euro Futures are priced at US$1.4150.
Question 3:
David PLC, A UK company, is due to pay 240,000 NAf (Dutch guilders) in 3 months time to Harmeling B.V a supplier in the Netherlands. The relevant rates are as follows: Money market rates (% per year) Deposit Borrowing 4% 8% 5% 9%
UK Netherlands Spot rates, Naf/: 2.7200 2.7350
Require d: Demonstrate how David PLC can use the money markets to hedge the currency risk.
Assuming the funds are obtained by borrowing sterling calculate the sterling cost of the transaction in three months time.
Question 4
An import Export merchant contracts on 31 December to buy 1,500 tonnes of product X from a supplier in Portugal at a price of Escudos 11,820 per tonne. Shipment will be made direct to a customer in Germany whom he has sold the product at DM 462 per tonne. Of the total quantity, 500 tonnes will be shipped during January and the balance by the end of February. Payment to the suppliers is to be made immediately on shipment, whilst one months credit form the date of shipment is allowed to the German customer. The merchant arranges with his bank to cover the transactions in Sterling on the forward exchange market, the exchange rates at 31 December being as given below: Escudos Spot 107.45 107.75 DM 3.84 3.88

1 month forward 2 months forward 3 months forward 55 105 c dis 75 175 c dis 106 250 c dis 21/2 11/2 pf premium 4 3 pf premium 61/2 51/2 pf premium
231
Exchange commission 1 per mille (maximum Sterling 10) on each transaction
Require d:
(a) Calculate (to the nearest sterling) the profit the merchant will make on the transaction [10 Marks] (b) Explain how the calculations of further exchange profit or loss would be made if : (i) (ii) The February shipment were cancelled; The February shipment was delayed until April Total [10 Marks] [20 Marks]
Question 5: (a) German company exports goods to the USA and invoices their customer for
$526,000 payable in August. It is now June. Spot: August Forward: Spot $/DM August forward US$/DM 0.4070 1.4090 0.4130 1.4150
0.4070 - 0.4090 0.4130 0.4150
September DM futures contracts are priced at $ 0.41 (one-DM futures contract represents DM 80,000).
Require d:(i) Set up the hedge position

(ii) Calculate the hedge efficiency if, in August:
(4 marks)
$/DM spot 0.4150 - 0.4170 And September DM futures are priced at $ 0.41 (6 marks) (b) A UK Company imports from the USA and is invoiced for $297,500 payable in October. $/ Spot rate October fwd. (i) 1.7500 - 1.7520 1.7000 1.7015 (2
Show how a forward market hedge would be carried out marks)

(ii)
232
Show how a future market hedge be carried out (one futures contract (4 marks)
represents 12,500 and December futures are priced at $1.70. (iii) What would be the result of the futures market hedge if $/ spot turned
out to be 1.7800 - 1.7820 in October and December futures were priced at $1.78? (4 marks) (Total: 20 marks)
Question 6: is late November. On LIFFE the three-month time deposit interest rate futures It
contracts are priced as follows: Dec Euro $ Euro DM Euro ECU 93.57 94.00 94.84 93.99 March 92.77 93.51 94.63 93.62
All contract sizes are for one million units of the currency except where the contract size is 500,000. The tick size is 0.01%.
Required:
(a) A company can currently borrow on the money market as at 10% per annum. It has a need for a 3.8m, 5- month loan from mid February. Hedge the companys exposure to interest rate risk and compute the hedge efficiency if, by mid February, market interest rates have moved to 11%. (8 marks) (b) Another company will have DM 11.7m surplus for one month from 1st January, DM deposit rates are 5% per year. Set up the hedge and compute the hedge efficiency if by 1st January deposit rates have risen by 0.5% and March Euro DM contracts are priced at 94.03. (6 marks) (c) A third company has a floating rate ECU 50m loan with a three month roll over at LIBOR + 0.5%. The next roll is due on 1st January, and the company fears that LIBOR will rise over the next few months. Show how the company can hedge the next two rolls over. (No calculations are required). (4 marks) (Total: 18 marks)
233
Question 7: UK company owes a French creditor FF 3,500,000 in three months time. The spot A
exchange rate is FFF/7.5509 7.5509. The company can borrow in Sterling for 3 months 8.60% per annum and can deposit FF for 3 months at 10% per annum.
Required:
What is the cost in pounds with a money market hedge and what effective forward rate would this represent?
Question 8:
Tumbo Ltd a Tanzanian based UK Company has bought goods from a US supplier, and must pay $4,000,000 for them in three months time. The companys finance director wishes to hedge against the foreign exchange risk, and the three methods, which the company usually considers, are: (a) (b) (c) Using forward exchange contracts Using money market borrowing or lending Marking lead payments
The following annual interest rate and exchange rates are currently available. US dollar Deposit Borrowing rate rate % % 7 10.25 7 10.75 Sterling Deposit Borrowing rate rate % % 10.75 14.00 11.00 14.25
1 month 3 months
Spot 1 month forward 3 months forward
$/ Exchange rate ($ = 1) 1.8625 1.8635 0.60c 0.58c pm 1.80c 1.75 pm
Require d:
Which is the cheapest method for Tumbo Ltd? Ignore commission costs (the bank charges for arranging a forward contract or a loan).
Question 9
On July 1 the spot exchange rate for US dollars against the D-Mark is $DM 0.583. D Mark September futures are trading at a price of $/DM 0.5800. Note that the spot rate and the future price will be close together, but not exactly the same. As with currency forward contracts, the difference represents the interest rate differential between dollars and deutschmarks for the period 1 July to 30 September, Future events will normally cause the spot rate and the futures price to move in the
234
same direction. If the deutschmark spot price strengthens; the futures price will also strengthen. Your company needs to buy one million deutschmarks with US dollars on July 31. You are happy with the July 1 exchange rate but are afraid that the deutschmark might strengthen over the next month. You decide to Lock into todays exchange rate by buying 8 deutschmarks September contracts at $/DM 0.5800. If the deutschmark strengthens on the spot market, you will be able to sell the future contracts at a profit, which will pay for the more expensive deutschmarks.
Illustrate the effect of using the future hedge under the following two scenarios. (a) The deutschmark spot exchange rate strengthens to $/DM 0.6030 and the September future price moves to $/DM 0.6000. (b) The deutschmark spot exchange rate weakens to $DM 0.5630 and the September futures price moves to $/DM 0.5600.
Require d
Nana Ltd, a URT company, will receive a dividend of three million Euros in 70 days time.
Question 10
Required
What action should it take on the futures market to hedge currency risk?
Question 11 Gairo Ltd, a Tanzanian company, needs to pay US dollars to an American supplier in 90
days.
How can it hedge the transaction using currency futures?
Require d
Question 11 In July, suppose the following figures are quoted.
Sterling futures: contract size 62,500: price in $ per 12 July price Sep 1.5552 Dec 1.5556 Mar 1.5564 Your company, based in Britain will receive US$2,000,000 on 13 December 2005.
Require d Question How should you hedge the receipt using futures? 12
Great Eastern plc, a British company, has purchased steel worth Y 100 million from Japan and needs to pay for this in 90 days time.
Requir ed
235
How can it hedge the cost of the purchase by using currency futures? On IMM the Japanese yen future is trading at $0.8106 per 100 yen and the Sterling future is trading at $1.6250 per pound.
Alpha Ltd, a UK company based in Tanzania. Imports and exports to the USA. On 1 May it signs three agreements, all of which are to be settled on 31 October: (a) (b) (c) A sale to a US customer of goods for $205,500 A sale to another US customer for 550,000 A purchase from a US supplier for $875,000
Question 13
On 1 June the $/ spot rate is 1.5500 1.5500 and the October forward rate is at a premium of 4.00 - 3.95 cents per pound. Sterling futures contracts are trading at the following prices: Sterling futures (IMM) Contract size 62,500 Contract settlement date Jun Sep Dec Contract price $ per 1.537 1.5180 1.4970
Requi red
(a) (b) (c) Compute the net amount receivable or payable in pounds if the transactions are covered on the forward market. Show how a futures hedge could be set up. Compute the result of the futures hedge if, by 31 October, the spot market price for dollars has moved to 1.5800 1.5820 and the December sterling futures price has moved to 1.5650. Discuss the efficiency of the futures hedge.
(d)
On 1, December, Tupendane Ltd a Tanzanian based- UK company forecast a cash deficit of up to 3m for the four month period 1 February 31 May, and proposed to take out a loan for this amount on 1 February. The corporate treasure is worried that in the intervening period interest rates might rise. You are given the following information: LIFFE 500,000 3- month time deposit future prices: December March 91.25 91.44
Question 14

June September 91.33 91.18
236
Both 3 month and 6-month certificates of deposit (CDs) were quoted at 8.8% quoted at 8.8% (annualized rate). The company can borrow at the CD rate. On 1 February, the following prices prevailed: March June September 89.34 89.01 88.92
The CD rate was 11.20% for both 3 and 6-month deposits. The loan was taken out as planned.
Requi red
(a) Provide a reasoned analysis of Tupendane Ltd`s problem and recommend a suitable hedging strategy as at 1 December, justifying the type and number of contracts chosen. (10 marks) (b) Evaluate the success (ex post) of your strategy using 1 February data, and explain why the hedge was not perfect. (8 marks) (Total: 18 marks)
It is now 31 December 2004. The corporate treasurer of Umoja plc a UK based Tanzanian company is concerned about the level of cash flows of the company during the next six months, and how the company might be protected from the adverse effects of changing Interest rates. Interest rate are widely expected to change in late April when a general election is due, but the size and direction of the change is dependent upon the result of the election, which is forecast by opinion polls to be very close. Current interest rates for Umoja are 11% per year for short- term borrowing and 8% per year for short-term investment. Sales of the company in December 19x2 were 824,180 units at a price of 10.60 per unit. Sales have been recently increasing at the rate of 1.5% per month, and this trend is expected to continue. Two months credit is given to all customers and one months credit is received on all purchases. Materials with a unit variable cost of 3.71 are purchased to meet expected
Question 15
237
sales in two months time. Direct labour costs 3.18 per unit and wages are payable one month in arrears. Production levels are based upon expected sales in one months time. Overheads, payable one month in arrears, are expected to be 1,950,000 per month (invoice value) for the next three months, and 2,010,000 per month for the following six months. Sales price, material and labour costs are expected to rise by 5% in early march 19x3. No other changes in price or costs are expected. Other forecast cash flows are: (a) (b) March replace 150 salesmens cars at a net cost of 900,000. May(i) (ii) Purchase new machinery for planned expansion at a cost of 2,381,000. Disposal of a plot of land for the sum of 1,990,000, 1,300,000 receivable in May and 690,000receivable in June (c) A dividend of 1,817,000 is payable in June and taxation of 5,700,000 is payable in April. There will be an opening cash balance of 800,000 at the beginning of January 199x3. Apart from an overdraft facility to finance short -term cash shortages, the company has no other form of floating rate debt. June sterling three -month time deposit futures are currently priced at 90.25. The standard contract size is 500,000 and the minimum price movement is one tick (the value of one tick is 0.01% per year of the contract size). Interest rate guarantees at 11.5% per year for a two month period from May are available to Umoja for a premium of 0.2% of the size of the loan to be guarantees. Forward rate agreements are available for periods of up to four months from May at 11.88 - 11.83%.
Requi red

(a)
238
Prepare a report discussing the advantages and disadvantages of alternative strategies that the managers of Umoja might adopt to protect the company from interest rate risk associated with the companys expected cash flow during the next six months. The company does not wish to seek speculative profits from interest rate movements. State clearly any assumption that you make and include relevant calculations as part of your report. (24 marks)
(b)
If at the end of April rates moved as follows: (i) Borrowing rate for Umoja 13% per year Investment rate for Umoja 10% per year June sterling three- month time deposit futures 88.05. (ii) Borrowing rate for Umoja 9.5% per year Investment rate for Umoja 6.8% per year June sterling three-month time deposit futures 91.75.
Requi red Evaluate with hindsight, separately for each of scenario (i) and (ii) above, the results of four alternative strategies that the company might have adopted towards its interest rate risk. Taxation, margin requirements and the time value of money may be ignored.
(16 marks) (Total: 40 marks)
Require

Chapter 10 - Forward and Futures Contracts Examples

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Chapter 10 - Forward and Futures Contracts Examples

Uploaded by

Copyright:

Available Formats

Chapter 10 Forward and Futures Contracts