Futures November 1999 Futures Warning This workbook is the product of, and copyrighted by, Citicorp North America, Inc It is solely for the internal use of Citicorp North America, Inc and may not be used for any other purpose It is unlawful to reproduce the contents of these materials, in whole or in part, by any method, printed, electronic, or otherwise; or to disseminate or sell the same without the prior written consent of the Training and Development Centers for Latin America, Asia/Pacific and CEEMEA Please sign your name in the space below (This page is intentionally blank) Table of Contents TABLE OF CONTENTS Introduction Course Overview v Course Objectives v The Workbook vi Unit 1: Fundamentals of Futures Introduction 1-1 Unit Objectives 1-1 Development of Futures Contracts 1-1 Forward Contracts 1-1 The Need to Reduce Credit Risk 1-2 Contract Characteristics 1-4 Closing Out a Position 1-6 Participation in the Futures Market 1-7 Summary 1-7 Progress Check 1-9 Unit 2: Futures Markets - The Key Players Introduction 2-1 Unit Objectives 2-1 The Players 2-1 Types of Traders 2-1 Speculators 2-1 Arbitragers 2-2 Locals 2-2 Hedgers 2-2 Participation in the Futures Market 2-3 Trading for Profit 2-3 Trading to Reduce Risk 2-3 v11/02/99 p01/24/00 v-1.2 ii TABLE OF CONTENTS Unit 2: Futures Markets - The Key Players (Continued) Hedging Strategies 2-3 Risk Reduction 2-3 Hedging versus Speculating 2-5 Summary 2-6 Progress Check 2-7 Unit 3: Futures Market Prices Introduction 3-1 Unit Objectives 3-1 Market Awareness 3-1 Pricing 3-6 The “Underlying” 3-6 Futures Contract Price vs Cash Market Price 3-6 Margin Payments 3-8 Summary 3-9 Progress Check 3-11 Unit 4: Interest-rate Futures Introduction 4-1 Unit Objectives 4-1 Major Types of Interest-rate Futures Contracts 4-1 Cash-settled Futures Contracts 4-2 Deliverable Contract 4-3 Using Interest-rate Futures to Hedge Interest-rate Risk 4-4 Additional Considerations When Hedging with Futures 4-6 Who Should Use Futures for Hedging? 4-8 Summary 4-10 Progress Check 4-13 v-1.2 v11/02/99 p01/24/00 TABLE OF CONTENTS v Unit 5: Currency Futures Introduction 5-1 Unit Objectives 5-1 Currency Futures Contracts .5-1 Contract Features .5-2 Hedging with Currency Futures .5-4 Summary .5-5 Progress Check 5-9 Appendices Appendix A: The Mechanics of Futures Markets A-1 Appendix B: ISO Codes B-1 Appendix C: Financial Derivatives Exchanges’ Websites C-1 Glossaries English .G-1 Spanish G-5 Index v11/02/99 p01/24/00 v-1.2 iv TABLE OF CONTENTS (This page is intentionally blank) v-1.2 v11/02/99 p01/24/00 G-2 GLOSSARY Forward Contract A binding commitment to either buy or sell an asset in the future at a predetermined price, or to pay/receive in cash the amount of loss/profit caused by a change in an asset's price from the predetermined level Futures Contract A standardized agreement to buy or sell (or effect the financial equivalent of buying or selling) a specific quantity and grade of an asset on a specified future date at a pre-defined price (often determined through open outcry) in a regulated marketplace with a margining system, which minimizes credit risk Futures Exchange Financial marketplace for the trading of futures contracts Futures Market An exchange site that provides a specialized trading floor for the buying and selling of assets for future delivery Futures Market Order Buy or sell order given by the client to a broker Good 'til Canceled (GTC) Order that remains in effect until customer instructs the broker to cancel Hedgers Traders that try to reduce the risks associated with holding, or planning to hold, positions in various markets These risks may arise from adverse movements in interest rates and/or exchange rates, or from changes in prices of stocks or commodities Hedging Taking a position with a futures contract that offsets a position in another market to minimize risk Index An indicator that reflects economic conditions (for example, a stock market index) ISO International Standards Organisation A regulatory body that ratifies internationally accepted protocol for communications in business Last Trading Day Last business day before final settlement of a contract v-1.2 v11/02/99 p6/14/00 GLOSSARY G-3 Leverage Ability to control large amounts of resources with small amounts of capital; a high-risk profit opportunity that is disproportionate to the amount invested Limit Order Order to buy or sell at a specified price or better Long Position Position held by the buyer of a futures contract Margin See "Initial Margin Deposit" and "Variation Margin" Mark-to-Market Process of comparing the contract rate to current market conditions Market-IfTouched Order (MIT) Combines a market order and limit order; becomes a market order when the specified price is reached or passed For sell orders, this specified price is above the market price when the order is initiated For buy orders, this specified price is below the market price when the order is initiated Market Order Order to trade at best available price immediately Mimicking Movement of the price of an underlying asset either closely with, or inversely against, a macroeconomic trend Not Held Instructions to the pit trader to use his/her best judgment once the order conditions are met Offset Transaction that cancels out an equal and opposite transaction Open Interest The number of outstanding contracts which have not been offset Open Outcry Method used by buyers and sellers on the floor of many futures exchanges to verbally fix contracts Quotation Price per contract Settle Price Average price of all trades taking place during the last minute of the trading day Settlement Date Date by which an executed order must be completed Short Position Position held by the seller of a futures contract v11/02/99 p6/14/00 v-1.2 G-4 GLOSSARY Speculation Engaging in risky transactions which offer the possibility of large returns or losses Speculators Traders who try to profit from speculation Stop-limit Order Stop order that becomes a limit order when a specified price is reached Stop Order Similar to market-if-touched order It becomes a market order when the specified price is reached or passed For sell orders, this specified price is below the market price when the order is initiated For buy orders, this specified price is above the market price when the order is initiated Tick The minimum price movement for a futures contract Underlying An asset or intangible on which a futures contract is based Variation Margin Amount of funds a trader must add, or can withdraw, as the market price of an asset varies Yield Measure of the interest rate implicit in the price of a future v-1.2 v11/02/99 p6/14/00 GLOSSARY G-5 GLOSARIO Arbitrage/ Arbitraje Compra y venta simultánea de los mismos activos o activos estrechamente relacionados en diferentes mercados el fin de aprovechar valores desiguales Arbitrager / Arbitrajista Un operador que hace jugar un mercado contra el otro, buscando un producto determinado que está sobrevaluado en un mercado en relación el otro Basis Risk / Riesgo de Base Riesgo de que el precio o la tasa de un contrato financiero no cambie en forma idéntica el precio o la tasa de otro contrato financiero Buying on Margin / Compra sobre el Margen Porción del precio de compra de acciones del mercado tomada del comisionista Cash Contract / Contrato al Contado Acuerdo de comprar o vender un activo para entrega inmediata Clearinghouse / Cámara de Compensaciones Sistema dentro de una bolsa que facilita la entrega y recibo de contratos de futuros Contract Delivery Month / Mes de Entrega del Contrato Ultimo mes de un contrato de futuros durante el cual debe efectuarse la entrega, a menos que el contrato se compense Cost of Carry / Costo de Mantenimiento Costo de mantener un contrato hasta la fecha de entrega Currency Futures / Futuros de Moneda Un contrato de futuros que se usa para cubrir transacciones en moneda Daily Maxima / Máxima Diaria Límites máximos de fluctuación de precio hacia arriba o hacia abajo para contratos de futuros Day-limit Order / Orden de Límite Diario Orden que permanece activa por un día v11/02/99 p6/14/00 v-1.2 G-6 GLOSSARY Fill or Kill (FOK) / Cumplir o Anular Orden de que el comisionista de bolsa cumpla inmediatamente o cancele después de tres ofertas de compra o venta; puede resultar en una orden parcialmente cumplida Floor Brokers / Comisionistas de Bolsa Miembros de la bolsa de futuros que están afiliados a una firma miembro y asumen la responsabilidad de ejecutar las órdenes de la firma Forward Contract / Contrato a Término Un compromiso vinculante de comprar o vender un activo en el futuro a un precio determinado, o de pagar/recibir al contado el monto de pérdida/ganancia causada por un cambio en el precio de un activo desde el nivel predeterminado Futures Contract / Contrato de Futuros Un acuerdo estandardizado de comprar o vender (o efectuar el equivalente financiero de comprar o vender) una cantidad y calidad específica de un activo en una fecha futura especificada a un precio predefinido (a menudo determinado a viva voz) en una plaza regulada un sistema de márgenes, que minimiza el riesgo de crédito Futures Exchange / Bolsa de Futuros Plaza financiera para la negociación de contratos de futuros Futures Market / Mercado de Futuros Un lugar de intercambio que brinda un recinto de trading especializado para la compra y venta de activos para entrega futura Futures Market Order / Orden del Mercado de Futuros Orden de compra o venta dada por el cliente a un comisionista Good ‘til Canceled (GTC) / Vigente hasta su Cancelación Orden que permanece vigente hasta que el cliente instruye al comisionista para que cancele v-1.2 v11/02/99 p6/14/00 GLOSSARY G-7 Hedgers / Reductores de Riesgo Operadores que tratan de reducir los riesgos relacionados mantener, o planear mantener, posiciones en varios mercados Estos riesgos pueden surgir de movimientos adversos en las tasas de interés y/o tipos de cambio, o de cambios en los precios de las acciones o commodities Hedging / Tomar Cobertura Tomar una posición un contrato de futuros que compensa una posición en otro mercado para minimizar el riesgo Index / Indice Un indicador que refleja las condiciones económicas (por ejemplo, un índice del mercado de valores) Initial Margin Deposit / Depósito de Margen Inicial Un depósito de buena fe pagado por los compradores y vendedores en el mercado de futuros Last Trading Day / Ultimo Día de Trading Ultimo día laboral antes de la liquidación final de un contrato Leverage / Apalancamiento Capacidad de controlar grandes montos de recursos pequeños montos de capital; una oportunidad de ganancia de alto riesgo que no está en proporción el monto invertido Limit Order / Orden Limitada Orden de comprar o vender a un precio especificado o mejor Long Position / Posición Comprada Posición mantenida por el comprador de un contrato de futuros Margin / Margen Ver “Depósito de Margen Inicial” o “Margen de Variación” Mark-to-Market / Ajustar a Valor de Mercado Proceso de comparar la tasa del contrato las condiciones del mercado actuales v11/02/99 p6/14/00 v-1.2 G-8 GLOSSARY Market-If-Touched-Order (MIT) / Orden de Operar al Llegar al Precio Combina una orden de operar y una orden limitada; se convierte en una orden de operar cuando se alcanza o se pasa el precio especificado Para ordenes de vender, este precio especificado está por encima del precio de mercado cuando se inicia la orden Para ordenes de comprar, este precio especificado está por debajo del precio de mercado cuando se inicia la orden Market Order / Orden de Operar Orden de operar al mejor precio disponible inmediatamente Mimicking / Imitación Movimiento del precio de un activo subyacente de acuerdo una tendencia macroeconómica o en forma inversa contra la misma Not Held / No Mantener Instrucciones para el operador de utilizar su mejor criterio una vez que se cumplen las condiciones de la orden Offset / Compensación Transacción que cancela una transacción igual y opuesta Open Interest / Interés Abierto El número de contratos pendientes que no fueron compensados Open Outcry / Viva Voz Método empleado por compradores y vendedores en el recinto de muchas bolsas de futuros para fijar contratos verbalmente Quotation / Cotización Precio por contrato Settle Price / Precio de Liquidación Precio promedio de todas las operaciones que se producen durante el último minuto del día de trading Settlement Date / Fecha de Liquidación Fecha en la cual debe cumplirse una orden ejecutada Short Position / Posición Vendida Posición mantenida por el vendedor de un contrato de futuros v-1.2 v11/02/99 p6/14/00 GLOSSARY G-9 Speculation / Especulación Hacer operaciones riesgosas que ofrecen la posibilidad de grandes retornos o pérdidas Speculators / Especuladores Operadores que tratan de obtener ganancia de la especulación Stop-limit Order / Orden de SuspenderLimitada Orden de suspender que se convierte en una orden limitada cuando se alcanza un precio especificado Stop Order / Orden de Suspender Similar a la orden de operar al llegar al precio Se convierte en una orden de operar cuando se alcanza o pasa el precio especificado Para órdenes de vender, este precio especificado está por debajo del precio de mercado cuando se inicia la orden Para órdenes de comprar, este precio especificado está por encima del precio de mercado cuando se inicia la orden Tick / Valor Mínimo de Variación El movimiento de precio mínimo para un contrato de futuros Underlying / Activo Subyacente Un activo o bien intangible sobre el que se basa un contrato de futuros Variation Margin / Margen de Variación Monto de fondos que un operador debe agregar, o puede retirar, a medida que varía el precio de mercado de un activo Yield / Rendimiento Medida de la tasa de interés implícita en el precio de un futuro v11/02/99 p6/14/00 v-1.2 G-10 GLOSSARY (This page is intentionally blank) v-1.2 v11/02/99 p01/24/00 Index INDEX A Arbitrage Arbitrager 2-2, 2-3 2-1—2-3, 2-6 B Basis Risk Buying on Margin 4-7, 4-8, 4-10 3-8 C Cash Contract Clearinghouse Contract Month Cost of Carry Currency Futures 1-4 1-4, 5-3, A-2, A-3 3-1, 3-3, 3-5 3-7, 3-9 5-1—5-6 D Daily Maxima Day-limit Order A-1 A-5 F Fill or Kill (FOK) Floor Brokers Forward Contract Futures Contract Futures Market Order A-8 A-4, A-5 1-1—1-5, 1-7, 1-8, 4-1, 4-8—4-10, 5-1, 5-2, 5-5, 5-6 1-1, 1-3—1-8, 2-2, 2-4, 2-5, 3-1, 3-4, 3-6, 3-8—3-10, 4-1—4-3, 4-7, 4-8, 4-10, 4-11, 5-1—5-6, A-1—A-4 1-4, 3-7, 4-3, A-1—A-3, A-10 1-1, 1-7, 1-8, 2-1—2-5, 3-1, 3-9, 4-1, 4-9, 5-4, 5-6, A-1, A-2 A-4 G Good 'til Canceled (GTC) A-8 Futures Exchange Futures Market v11/02/99 p01/24/00 v-1.2 I-2 INDEX H Hedgers Hedging 2-1—2-3, 2-6, 4-7, 5-4, 5-5 2-1—2-6, 4-6—4-8, 5-1, 5-4, 5-5, A-10 I Index Initial Margin Deposit ISO 2-5, 4-4, 4-7—4-9 1-4, 1-8, 3-8, 3-10 B-1 L Last Trading Day Leverage Limit Order Locals Long Position A-6, A-7 2-2, 2-6, A-1 A-5, A-7—A-9 2-1, 2-2, 2-3, 2-6 1-6, A-6, A-7 M Margin Mark-to-Market Market-If-Touched Order Market Order Mimicking 1-2—1-7, 1-8, 2-2, 3-1, 3-8, 3-9, 4-1—4-3, 4-8, 4-10, 5-2—5-6, A-1, A-3, A-11 1-2—1-4, 1-8, 4-1, 4-2, 4-10, 5-2, 5-5, A-3 A-5—A-7, A-9 A-4, A-5, A-7 2-4, A-10 N Not Held A-9 O Offset Open Interest Open Outcry 1-3, 1-6—1-8, 2-2, 2-4, 2-6, 3-4, 4-7, 4-8, 5-3, 5-5, 5-6 3-4, 3-5, 3-9, 4-10 1-6 Q Quotation 3-4, 3-5 v-1.2 v11/02/99 p01/24/00 INDEX I-3 S Settle Price Settlement Date Short Position Speculation Speculators Stop-limit Order Stop Order 3-1, 3-3, 3-4, 3-9, 5-3 3-4, 4-2, 4-9, 5-2, 5-5 1-7, 5-3 2-1, 2-2, 2-5 2-1—2-3, 2-6 A-7, A-9 A-6, A-7 T Tick 4-2, 4-3, 5-2, 5-3 U Underlying 1-4, 1-6, 1-7, 2-4 2-5, 3-1, 3-4—3-7, 4-7, 4-8, 4-11, 5-5, A-4, A-10 V Variation Margin 3-8, 3-9, 3-10, 4-2, 4-5, 4-10, 5-4, A-3 Y Yield 3-4, 3-7, 3-9, 5-5 v11/02/99 p01/24/00 v-1.2 ` I-4 INDEX (This page is intentionally blank) v-1.2 v11/02/99 p01/24/00 [...]... glossary item in the workbook v-1.2 v11/02/99 p01/24/00 INTRODUCTION ix Each unit covers some aspect of futures trading The units are: n UNIT 1 – Fundamentals of Futures n UNIT 2 – Futures Markets - The Key Players n UNIT 3 – Futures Market Prices n UNIT 4 – Interest-rate Futures n UNIT 5 – Currency Futures Since this is a self-instructional course, your progress will not be supervised We expect you... workbook, you will be introduced to futures, including the benefits of futures contracts, as well as the limitations of futures contracts COURSE OBJECTIVES When you complete this workbook, you will be able to: n Describe a futures transaction n Interpret a newspaper report of futures trading n Explain how futures contracts differ from forward contracts n Determine whether futures or forwards would be preferrable... credit risk with mark-tomarket margining, and is established through an organized exchange A futures contract is usually closed out with offsetting transactions by both parties before the specified future date Standardization and the reduction in credit risk due to mark-tomarket margining allow for greater diversity of participation in the futures market than in the forward market You have now completed... that futures sellers have for closing out their position a) They can offset their position by buying an identical contract for the same delivery month d) They can deliver the assets v-1.2 v11/02/99 p01/24/00 Unit 2 UNIT 2: FUTURES MARKETS – THE KEY PLAYERS INTRODUCTION Now that you are familiar with the fundamentals of futures, let's see how the futures markets operate Why do traders engage in futures... Participation in the Futures Market Standardization increases liquidity The standardization of contract terms helps to increase the liquidity (volume of trading) in individual futures contracts because parties with similar, though different, positions choose the same futures contract The strict margining process removes credit risk, which allows for greater participation in the futures market than in the... technical knowledge and market expertise essential to the development of effective hedging and trading strategies n Create new futures products such as stock index futures n Participate in exchanges in many different countries n Explain how and why futures contracts differ from forward agreements Many units of Citicorp are major users of futures contracts They purchase and sell futures contracts in order... FUNDAMENTALS OF FUTURES INTRODUCTION Futures transactions have increased substantially in the past 20 years Futures and interest-rate forwards share some common characteristics, but they differ in other important ways In this unit, you will learn how futures contracts are structured and used, and how they differ from interest-rate forwards This unit will provide a foundation for your study of futures markets... buy or sell futures contracts that serve as substitutes for later positions in a physical market in order to reduce risk v-1.2 v11/02/99 p01/24/00 FUTURES MARKETS – THE KEY PLAYERS 2-3 Participation in the Futures Market Traders participate in the futures market either to make a profit or to reduce risk Trading for Profit Speculators and arbitragers Both speculators and arbitragers (including locals)... Since T-bond futures are quoted in USD 100,000 lots, he buys 100 T-bond futures in order to lock in today's futures interest rate 2) A Japanese exporter of robots will receive USD 1,000,000 in six months She is worried that the U.S dollar might fall in value against the Japanese yen She buys Japanese yen futures contracts, agreeing to pay U.S dollars in the future and receive yen in the future This... definition best describes a futures contract? _ a) Agreement to buy an asset on a designated future date, at a floating rate _ b) Standardized contract to buy or sell an asset at a specified price, at some unspecified future time _ c) Standardized contract to buy or sell an asset at a specified price on a specific future date _ d) Agreement to sell an asset in the cash market, at a specified price