Chapter 22 - Futures Markets

CHAPTER22:FUTURESMARKETS
PROBLEMSETS
1.

Thereislittlehedgingorspeculativedemandforcementfutures,sincecementpricesare
fairlystableandpredictable.Thetradingactivitynecessarytosupportthefuturesmarket
wouldnotmaterialize.

2.

Theabilitytobuyonmarginisoneadvantageoffutures.Anotheristheeasewithwhichone
canalteronesholdingsoftheasset.Thisisespeciallyimportantifoneisdealingin
commodities,forwhichthefuturesmarketisfarmoreliquidthanthespotmarket.

3.

Shortsellingresultsinanimmediatecashinflow,whereastheshortfuturesposition
doesnot:
Action

InitialCF

ShortSale
ShortFutures
4.

a.

+P0
0

FinalCF
PT
F0PT

False.Foranygivenlevelofthestockindex,thefuturespricewillbelowerwhen
thedividendyieldishigher.Thisfollowsfromspotfuturesparity:
F0=S0(1+rfd)T

b.

False.Theparityrelationshiptellsusthatthefuturespriceisdeterminedbythestock
price,theinterestrate,andthedividendyield;itisnotafunctionofbeta.

c.

True.Theshortfuturespositionwillprofitwhenthemarketfalls.Thisisanegative
betaposition.

5.

Thefuturespriceistheagreeduponpricefordeferreddeliveryoftheasset.Ifthatprice
isfair,thenthevalueoftheagreementoughttobezero;thatis,thecontractwillbea
zeroNPVagreementforeachtrader.

6.

Becauselongpositionsequalshortpositions,futurestradingmustentailacanceling
outofbetsontheasset.Moreover,nocashisexchangedattheinceptionoffutures
trading.Thus,thereshouldbeminimalimpactonthespotmarketfortheasset,and
futurestradingshouldnotbeexpectedtoreducecapitalavailableforotheruses.
22-1

Chapter 22 - Futures Markets

7.

a.

TheclosingfuturespricefortheMarchcontractwas1,477.20,whichhasadollar
valueof:
$2501,477.20=$369,300
Therefore,therequiredmargindepositis:$36,930

b.

Thefuturespriceincreasesby:1,500.001,477.20=22.80
Thecredittoyourmarginaccountwouldbe:22.80$250=$5,700
Thisisapercentgainof:$5,700/$36,930=0.1543=15.43%
Notethatthefuturespriceitselfincreasedbyonly1.543%.

8.

c.

Followingthereasoninginpart(b),anychangeinFismagnifiedbyaratioof
(l/marginrequirement).Thisistheleverageeffect.Thereturnwillbe10%.

a.

F0=S0(1+rf)=$1501.06=$159

b. F0=S0(1+rf)3=$1501.063=$178.65

9.

c.

F0=1501.083=$188.96

a.

TakeashortpositioninTbondfutures,tooffsetinterestraterisk.Ifratesincrease,
thelossonthebondwillbeoffsettosomeextentbygainsonthefutures.

b.

Again,ashortpositioninTbondfutureswilloffsettheinterestraterisk.

c.

Youwanttoprotectyourcashoutlaywhenthebondispurchased.Ifbondprices
increase,youwillneedextracashtopurchasethebond.Thus,youshouldtakea
longfuturespositionthatwillgenerateaprofitifpricesincrease.

10.

F0=S0(l+rfd)=1,500(1+0.050.02)=1,545

11.

Theputcallparityrelationstatesthat:
P=CS0+X/(1+rf)T
IfX=F,then:P=CS0+F/(1+rf)T
Butspotfuturesparitytellsusthat:
F=S0(1+rf)T
Substituting,wefindthat:
P=CS0+[S0(1+rf)T]/(1+rf)T=CS0+S0whichimpliesthatP=C.

22-2

Chapter 22 - Futures Markets

12.

Accordingtotheparityrelation,theproperpriceforDecemberfuturesis:
FDec=FJune(l+rf)1/2=846.301.051/2=867.20
TheactualfuturespriceforDecemberislowrelativetotheJuneprice.Youshouldtake
alongpositionintheDecembercontractandshorttheJunecontract.

13.

a.

1201.06=$127.20

b.

Thestockpricefallsto:120(10.03)=$116.40
Thefuturespricefallsto:116.41.06=$123.384
Theinvestorloses:(127.20123.384)1,000=$3,816

14.

c.

Thepercentagelossis:$3,816/$12,000=0.318=31.8%

a.

TheinitialfuturespriceisF0=1300(1+0.0050.002)12=$1,347.58
Inonemonth,thefuturespricewillbe:
F0=1320(1+0.0050.002)11=$1,364.22
Theincreaseinthefuturespriceis16.64,sothecashflowwillbe:
16.64$250=$4,160.00

b.

Theholdingperiodreturnis:$4,160.00/$13,000=0.3200=32.00%

15.

Thetreasurerwouldliketobuythebondstoday,butcannot.Asaproxyforthis
purchase,Tbondfuturescontractscanbepurchased.Ifratesdoinfactfall,thetreasurer
willhavetobuybackthebondsforthesinkingfundatpriceshigherthanthepricesat
whichtheycouldbepurchasedtoday.However,thegainsonthefuturescontractswill
offsetthishighercosttosomeextent.

16.

TheparityvalueofFis:1,300(1+0.040.01)=1,339
Theactualfuturespriceis1,330,toolowby9.
ArbitragePortfolio

CFnow

CFin1year

ShortIndex
BuyFutures
Lend

1,300
0
1,300

ST(0.011,300)
ST1,330
1,3001.04

Total

22-3

Chapter 22 - Futures Markets

17.

a.

Futurespricesaredeterminedfromthespreadsheetasfollows:
Spot Futures Parity and Time Spreads
Spot price
1,500
Income yield (%)
1.5 Futures prices versus maturity
Interest rate (%)
3.0
Today's date
1/1/2008 Spot price
1,500.00
Maturity date 1
2/14/2008 Futures 1
1,502.67
Maturity date 2
5/21/2008 Futures 2
1,508.71
Maturity date 3
11/18/2008 Futures 3
1,519.79
Time to maturity 1
Time to maturity 2
Time to maturity 3

0.12
0.39
0.88
LEGEND:
Enter data
Value calculated
See comment

b.

Thespreadsheetdemonstratesthatthefuturespricesnowdecreasewithincreased
timetomaturity:
Spot Futures Parity and Time Spreads
Spot price
1,500
Income yield (%)
4.0 Futures prices versus maturity
Interest rate (%)
3.0
Today's date
1/1/2008 Spot price
1,500.00
Maturity date 1
2/14/2008 Futures 1
1,498.20
Maturity date 2
5/21/2008 Futures 2
1,494.15
Maturity date 3
11/18/2008 Futures 3
1,486.78
Time to maturity 1
Time to maturity 2
Time to maturity 3

0.12
0.39
0.88
LEGEND:
Enter data
Value calculated
See comment

18.

a.

ThecurrentyieldforTreasurybonds(coupondividedbyprice)playstheroleofthe
dividendyield.

b.

Whentheyieldcurveisupwardsloping,thecurrentyieldexceedstheshortrate.
Hence,Tbondfuturespricesonmoredistantcontractsarelowerthanthoseon
neartermcontracts.

22-4

Chapter 22 - Futures Markets

19.

a.
Action

CashFlows
T1

Now

LongfutureswithmaturityT1
ShortfutureswithmaturityT2
BuyassetatT1,sellatT2
AtT1,borrowF(T1)

0
0
0
0

P1F(T1)

Total

T2
0
F(T2)P2
+P2

0
P1
F(T1)

(T2T1)

F(T1)(1+rf)

(T2T1)

F(T2)F(T1)(1+rf)

b.

SincetheT2cashflowisrisklessandthenetinvestmentwaszero,thenanyprofits
representanarbitrageopportunity.

c.

Thezeroprofitnoarbitragerestrictionimpliesthat
F(T2)=F(T1)(1+rf)(T T )
2

CFAPROBLEMS
1.

a.

Thestrategythatwouldtakeadvantageofthearbitrageopportunityisareversecash
andcarry.Areversecashandcarryopportunityresultswhenthefollowing
relationshipdoesnotholdtrue:
F0S0(1+C)
Ifthefuturespriceislessthanthespotpriceplusthecostofcarryingthegoodstothe
futuresdeliverydate,thenanarbitrageopportunityexists.Atraderwouldbeabletosell
theassetshort,usetheproceedstolendattheprevailinginterestrate,andthenbuythe
assetforfuturedelivery.Atthefuturedelivery,thetraderwouldthencollectthe
proceedsoftheloanwithinterest,acceptdeliveryoftheasset,andcovertheshort
positioninthecommodity.

b.
CashFlows
Action

Now

Oneyearfromnow

Sellthespotcommodityshort
+$120.00
Buythecommodityfuturesexpiringin1year
$0.00
Contracttolend$120at8%for1year
$120.00

$125.00
$0.00
+$129.60

Totalcashflow

+$4.60

$0.00

22-5

Chapter 22 - Futures Markets

2.

3.

a.

Thecalloptionisdistinguishedbyitsasymmetricpayoff.IftheSwissfrancrises
invalue,thenthecompanycanbuyfrancsforagivennumberofdollarstoservice
itsdebt,andtherebyputacaponthedollarcostofitsfinancing.Ifthefrancfalls,
thecompanywillbenefitfromthechangeintheexchangerate.
Thefuturesandforwardcontractshavesymmetricpayoffs.Thedollarcostofthe
financingislockedinregardlessofwhetherthefrancappreciatesordepreciates.The
majordifferencefromthefirmsperspectivebetweenfuturesandforwardsisinthe
marktomarketfeatureoffutures.Theconsequenceofthisisthatthefirmmustbe
readyforthecashmanagementissuessurroundingcashinflowsoroutflowsasthe
currencyvaluesandfuturespricesfluctuate.

b.

Thecalloptiongivesthecompanytheabilitytobenefitfromdepreciationinthe
franc,butatacostequaltotheoptionpremium.Unlessthefirmhassomespecial
expertiseincurrencyspeculation,itseemsthatthefuturesorforwardstrategy,which
locksinadollarcostoffinancingwithoutanoptionpremium,maybethebetter
strategy.

Theimportantdistinctionbetweenafuturescontractandanoptionscontractisthatthe
futurescontractisanobligation.Whenaninvestorpurchasesorsellsafuturescontract,the
investorhasanobligationtoeitheracceptordeliver,respectively,theunderlyingcommodity
ontheexpirationdate.Incontrast,thebuyerofanoptioncontractisnotobligatedtoaccept
ordelivertheunderlyingcommoditybutinsteadhastheright,orchoice,toacceptdelivery
(forcallholders)ormakedelivery(forputholders)oftheunderlyingcommodityanytime
duringthelifeofthecontract.
Futuresandoptionsmodifyaportfoliosriskindifferentways.Buyingorsellingafutures
contractaffectsaportfoliosupsideriskanddownsideriskbyasimilarmagnitude.Thisis
commonlyreferredtoassymmetricalimpact.Ontheotherhand,theadditionofacallorput
optiontoaportfoliodoesnotaffectaportfoliosupsideriskanddownsiderisktoasimilar
magnitude.Unlikefuturescontracts,theimpactofoptionsontheriskprofileofaportfolio
isasymmetric.

4.

a. Theinvestorshouldselltheforwardcontracttoprotectthevalueofthebondagainst
risinginterestratesduringtheholdingperiod.Becausetheinvestorintendstotakea
longpositionintheunderlyingasset,thehedgerequiresashortpositioninthe
derivativeinstrument.
b.

Thevalueoftheforwardcontractonexpirationdateisequaltothespotpriceofthe
underlyingassetonexpirationdateminustheforwardpriceofthecontract:
$978.40$1,024.70=$46.30
Thecontracthasanegativevalue.Thisisthevaluetotheholderofalongpositionin
theforwardcontract.Inthisexample,theinvestorshouldbeshorttheforward
contract,sothatthevaluetothisinvestorwouldbe+$46.30sincethisisthecashflow
theinvestorexpectstoreceive.
22-6

Chapter 22 - Futures Markets

22-7

Chapter 22 - Futures Markets

c.

Thevalueofthecombinedportfolioattheendofthesixmonthholdingperiodis:
$978.40+$46.30=$1,024.70
Thechangeinthevalueofthecombinedportfolioduringthissixmonthperiodis:
$24.70
Thevalueofthecombinedportfolioisthesumofthemarketvalueofthebond
andthevalueoftheshortpositionintheforwardcontract.Atthestartofthesix
monthholdingperiod,thebondisworth$1,000andtheforwardcontracthasa
valueofzero(becausethisisnotanoffmarketforwardcontract,nomoney
changeshandsatinitiation).Sixmonthslater,thebondvalueis$978.40andthe
valueoftheshortpositionintheforwardcontractis$46.30,ascalculatedinpart
(b).
Thefactthatthecombinedvalueofthelongpositioninthebondandtheshort
positionintheforwardcontractattheforwardcontractsmaturitydateisequalto
theforwardpriceontheforwardcontractatitsinitiationdateisnotacoincidence.
Bytakingalongpositionintheunderlyingassetandashortpositioninthe
forwardcontract,theinvestorhascreatedafullyhedged(andhenceriskfree)
position,andshouldearntheriskfreerateofreturn.Thesixmonthriskfreerate
ofreturnis5.00%(annualized),whichproducesareturnof$24.70overasix
monthperiod:
($1,0001.05(1/2))$1,000=$24.70
TheseresultssupportVanHusensstatementthatsellingaforwardcontractonthe
underlyingbondprotectstheportfolioduringaperiodofrisinginterestrates.Theloss
inthevalueoftheunderlyingbondduringthesixmonthholdingperiodisoffsetby
thecashpaymentmadeatexpirationdatetotheholderoftheshortpositioninthe
forwardcontract;thatis,ashortpositionintheforwardcontractprotects(hedges)the
longpositionintheunderlyingasset.

5.

a.

Accurate.Futurescontractsaremarkedtothemarketdaily.Holdingashortposition
onabondfuturescontractduringaperiodofrisinginterestrates(decliningbond
prices)generatespositivecashinflowfromthedailymarktomarket.Ifaninvestorin
afuturescontracthasalongpositionwhenthepriceoftheunderlyingassetincreases,
thenthedailymarktomarketgeneratesapositivecashinflowthatcanbereinvested.
Forwardcontractssettleonlyatexpirationdateanddonotgenerateanycashflow
priortoexpiration.

22-8

Chapter 22 - Futures Markets

b.

Inaccurate.Accordingtothecostofcarrymodel,thefuturescontractpriceisadjusted
upwardbythecostofcarryfortheunderlyingasset.Bonds(andotherfinancial
instruments),however,donothaveanysignificantstoragecosts.Moreover,thecost
ofcarryisreducedbyanycouponpaymentspaidtothebondholderduringthelifeof
thefuturescontract.Anyconvenienceyieldfromholdingtheunderlyingbondalso
reducesthecostofcarry.Asaresult,thecostofcarryforabondislikelytobe
negative.

22-9