Futures

Futures
Futures Contract
A future contract is an agreement
between to parties to buy or sell an asset
at a certain time in future for a certain
price.
The buyer of the contract, who is said to be
long the contract has agreed to buy (take
delivery of) the goods in future.
The seller is said to be short the contract and
has obligation to sell (deliver) the goods in
the future.
Payoff for a buyer of Futures
60 55 65
0
Spot price
Profit/Loss
Payoff for a seller of Futures
60 55 65
0
Spot price
Profit/Loss
Futures Market in India
Stock index futures launched on 12
th
June, 2000
and stock futures in 9
th
Nov, 2001.
Futures on Stock Index and on individual stocks
NSE: S&P CNX Nifty Futures, CNXIT Futures, futures on
51 individual stocks
Commodity futures
Currency futures
Interest rate futures
NSE: Notional T Bills, Notional 10 year bonds (coupon
bearing and non-coupon bearing)

Futures Contract
Exchange traded products.
A standardized, transferable, exchange-
traded contract that requires delivery of a
commodity, bond, currency, or stock index,
at a specified price, on a specified future
date.
Forwards vs. Futures
A futures contract is like a forward contract:
Both specify that a certain commodity will be
exchanged for another at a specified time in the
future at prices specified today.
They represent zero net supply; for every buyer
there is a seller.
Profit-loss profile realized in forwards and
futures represent a zero sum game.
A futures contract is different from a
forward:
Futures are standardized; only the price in
negotiated: e.g. all December 2004 gold futures
contracts are identical in that the amount of gold
(contract size), quality of gold, delivery date and
place of delivery are specified. Forwards are
customized and all the aspects can be
negotiated.
Offesetting (prior to delivery date) a trade is
possible in futures market while it is non-existent
in most of the forward markets. For example, if
you are long Dec 2004 gold futures contract you
can close that position by later selling a Dec
2004 gold futures contract.
Default risk is least in case of futures. Since
forward contracts are agreements between the
two parties, each part face the counterparty
default risk.
Most future positions are eventually offset
and in many cases they are cash settled. In
contrast, most forward contracts terminate
with delivery of the specified good.
Margins and daily marking to market in case
of futures.
Futures Contract: Standard Features
Contract specification
Asset type
Exchange stipulates the grade of the asset.
Contract size
Specifies the amount of the asset to be delivered
under one contract.
Delivery agreement
The place of delivery
Delivery months
Futures are referred to by their delivery months.
Price quotes
Daily price movement limits
Daily price movement limits, termed as limit move
(limit up and limit down)
Position limits
Maximum number of contracts that a speculator may
hold

Clearing house
Clearinghouse of the exchange becomes the
opposite party to both buyers and sellers - thus
guarantees the performance of the parties to
each transaction.
Margin requirement
When two parties trade a futures contract, the
futures exchange requires some good faith
money (security) from both, to act as a
guarantee.
Initial Margin
Each exchange is responsible for setting the
minimum initial margin requirements. The initial
margin is the amount a trader must deposit into his
trading account (also called as margin account)
when establishing a position.
Exchanges use SPAN (Standard Portfolio Analysis of
Risk) to establish initial margin requirement.

Beyond the initial margin, if the equity in the account
falls below a maintenance margin level, additional
funds must be deposited to bring the account back up
to the initial margin level. The process is known as
margin call. The amount that is to be deposited is
termed as variation margin.
Once a trader has received the margin call, he must
meet the call, even if the price has moved in his
favour.

For example, if the initial margin required to
trade per gold futures contract is $1000, and the
maintenance margin level is $750, then an
adverse change of $2.60/oz. will result in a
margin call. Because one gold futures covers 100
oz. of gold a decline of $2.60/oz in the futures
price will deplete the long position by $260. The
trader with losses must deposit sufficient funds
to bring the margin to the initial level of $1000.
The margin that is deposited to meet margin call
is termed as variation margin.
Types of orders
Market order
Trade to be carried out immediately at the best price
Limit order
Specifies a particular price. The order can be
executed only at this price or at one more favouarble
to the investor.
Stop order or stop-loss order
Also specifies a particular price. The order is executed
at the best available price once a bid or offer is made
at a particular price or a less favorable price.
Stop-limit order
A combination of stop order and limit order.
Market-if-touched order
They are like limit orders, except that they become
market orders once a trade has occurred at the
specified price.
Discretionary order/Market-not-held order
Traded as a market order except that execution may
be delayed at the broker's discretion in an attempt to
get a better price.

Time orders
Unless specified, an order is a day order and expires
at the end of the trading day. Good-till-cancelled
remains active till executed or cancelled by the
customer. Some other time orders are Good-this-
week, Good-this-month etc.
Spread order
Specifies two trades that must be filled together. The
order can specify a difference in the prices or it can
be a market order.

Offsetting the positions (squaring up)
Most traders choose to close out their position
prior to delivery period specified in the contract
by entering into the opposite type of the trade.
Open Interest
Total number of contracts outstanding for a
particular delivery month.
Open interest is a good proxy for demand for a
contract.

Settlement
Physical settlement vs. Cash settlement
Settlement month
Settlement price

Marking to Market
All futures traders positions are marked to
market daily.
Also known as daily resettlement. It means
everyday, profits are added to, or losses are
deducted from the traders account.
Profits and losses are based on the changes in
the settlement prices or closing futures prices.

Contract specification: S&P CNX Nifty
Futures
Underlying index S&P CNX Nifty
Exchange of trading National Stock Exchange
Security descriptor N FUTIDX NIFTY
Contract size 200 and multiples thereof
Price steps Rs. 0.05
Trading cycle Maximum three month trading cycle
Expiry date Last Thursday of the expiry month or the previous
trading day if the last Thursday is a holiday
Settlement basis Mark to Market and final settlement is cash settled
on T+1 basis
Settlement price Daily settlement price will be the closing price of the
futures contracts for the trading day and the
final settlement price will be the closing value of
the underlying index on the last trading day
Marked to Market: An example
In NSE all future contracts are marked to market to the
daily settlement price. The profit loss are computed as
thus:
The trade price and the days settlement price for contracts
executed during the day but not squared up
Previous days settlement price and the current days
settlement price for brought forward contracts
Buy price and the sell price for contracts executed during the
day and squared up
Trade details Quantity
bought/sold
Settlement
price
MTM
Brought forward from
previous day
100@100 105 500
Traded during the day
Bought
Sold

200@100
100@102

102
200
Open position
(Not squared up)
100@100 105 500
TOTAL 1200
Source: NSE
Basis and Convergence
Basis and convergence explain the
relationship between futures price and cash
price.
Basis
Spot price (cash price) minus the futures price
In a normal market basis will be negative; since
future prices exceed spot prices and it is positive
in an inverted market.
Basis approaches zero as the delivery month is
approached.
Basis and Convergence
The process of basis moving towards zero
is termed as convergence. Why does it
happen?
It is due to arbitrage. For example, if future
price is above spot price during the delivery
period, the trader can
i. Short a futures contract
ii. Buy the asset
iii. Make delivery
Pricing Futures
Do the quoted prices reflect true value of the
underlying index?
Does there exist any opportunity for
arbitrage?
Why should the basis be negative in normal
markets?
The dynamics lies in the Cost-of-carry
model.
Cost of Carry Model
Cost of carry measures the storage cost,
plus the interest that is paid to finance the
asset less the income earned on the asset.
Cost of carry varies across the assets.
For a non-dividend paying stock, the cost of
carry is the risk free rate because there are no
storage costs and no income is earned.
For a commodity, storage cost is important.

Cost of Carry Model
The fair value of futures incorporates the
no-arbitrage limits on the prices. This is as
thus
F = S + CC - CR
F = Future prices
S = Spot price
CC = Holding costs or carry costs.
CR = Carry returns
Cost of Carry Model
For the stock index futures it can be mentioned
as

H(0,T) = rT/365, where r is the annual interest rate, T
is the number of days until delivery date and
E[FV(divs)] is the future value of all dividends paid by
the component of the stock index
| | | |
+ = FV(divs) - T) h(0, S S F
Cost of Carry Model
If

traders will engage in a cash-and-carry arbitrage which calls
for buying the spot index (it is relatively cheap) , carrying
it, and selling the futures (relatively expensive).

If

Traders will engage in a reverse cash-and-carry arbitrage which
calls for buying the futures and selling the spot, and investing the
proceeds.

| | | |
+ > FV(divs) - T) h(0, S S F

| | | |
+ < FV(divs) - T) h(0, S S F

Normal Backwardation and Contango
Normal backwardation
Futures prices are below expected future spot
prices, and futures price is expected to rise as
the delivery date approaches
Contango
A contango exists wherever the futures price lies
above the expected future spot price, and the
futures price generally declines as the delivery
date nears.
Buying a stock index futures contract and
buying Treasury bills is frequently called a
long synthetic stock position.
Buying shares of stock that replicates an
index and also selling a futures contract on
the stock creates a synthetic treasury bill.
Synthetic Stock and T Bills
Synthetic Stock
Illustration
An investor owns $9,523,800 in one year T-bills
which will be worth $10 million one year hence.
Take long position in stock index futures with an
underlying value equal to $9,523,800 (based on
spot index).
Suppose that index futures price is 1375 and the
spot is at 1325 and the futures contract
multiplier is 250.
Synthetic Stock
28.7511 futures will be purchased
($9,523,800/1325*250 )
Now suppose after one year spot price and
futures price are at 1500. The value of the
portfolio is
$10 million from T bills
$898,472 in stock index futures profit (125 250
28.7511)
Gain is 14.434%, given that investor began the
year with $9,523,800
Synthetic Stock
The 14.434% is identical to the return from
buying actual stocks, ignoring transaction costs.
The capital appreciation on the stock was
13.208%. (1500-1325/1325)
Had he purchased the stocks he would have
received the dividends and interest on those
dividends, and this dividend yield component
would have been 1.2264%.
Total return is 14.434%
Synthetic T bill
The arbitrageur buys the stock and locks in a
selling price by selling futures contract.
When performing a cash-and-carry
arbitrage, the synthetic T-bill is created by
borrowing at a lower rate and lending at a
higher rate, which is risk less.
Hedging with Futures
Hedgers use futures market to reduce a particular
risk that they face.
A perfect hedge is one that completely eliminates
the risk. In practice, these are rare.
When is the short futures position appropriate?
When is a long futures position appropriate?
Which futures contract should be used?
What is the optimal size of the futures position?
Hedging: The Basic Principle
The objective is usually to take a position
that neutralizes the risk as far as possible.
Consider an investor who will gain Rs.10,000 for
each rupee increase in the price of the
commodity over the next three months and lose
Rs.10,000 for each rupee decrease in the price
during the same period. To hedge, the investor
should take a short futures position that is
designed to offset the risk.
Short hedge
Involves a short position in futures contract.
Appropriate when the hedger has already owned
the asset and expects to sell it in future.
Can also be used when an asset is not owned
right now but will be owned at some time in
future.
Short hedge illustration
On May 15, 2004 an oil produces negotiated a
contract to sell 1 million barrels of crude oil. It
has been argued that price that will apply in the
contract is the market price on August 15. The
oil producer is therefore in the position where it
will gain $10,000 for each cent increase in the
price and lose $10,000 for each cent decrease
in the price.
Suppose that spot price on May 15 is $19 per
barrel and August crude oil futures price is
$18.75 per barrel. Each futures contract involves
the delivery of 1000 barrels.
The company can hedge by shorting 1000
August futures contracts.
If the oil producer closes out his position on
August 15, the effect of the strategy should be
to lock in a price close to $18.75 per barrel.

Long hedge
Long positions in a futures contract
More appropriate when one needs to purchase a
certain asset in the future and wants to lock in a
price now.
Long hedge illustration
On January 15 a copper fabricator knows it will
require 100,000 pounds of copper on May 15 to
meet certain contracts. The spot price of the
copper is 140 cents per pound, and the May
futures are priced at 120 cents per pound. Each
contract is for the delivery of 25,000 pounds of
copper.
The fabricator can hedge his position by taking a
long position in four May futures contract.
Hedging with Stock Index Futures
Long security Short index futures
Every buy position on a security is
simultaneously a buy position on the index.
As a way out a long position on a security can
be accompanied by sale of index futures.
One needs to know the beta of a security.
Illustration
Shyam adopts a position of Rs.1 million LONG
MTNL on date 5th June 2001. He plans to hold
the position till the 25th.
Suppose the beta of MTNL happens to be 1.2.
Hence he needs a short position of Rs.1.2 million
on the index futures market to totally remove his
Nifty exposure.

On date 5th June 2001, Nifty is 980 and the
nearest futures contract (with expiration 28th
June 2001) is trading at about 1000. Hence,
each market lot of the futures (200 nifties) is
worth Rs.200,000. To sell Rs.1.2 million of Nifty,
we need to sell 6 lots (by rounding off to the
nearest market lot).
He sells 6 market lots of Nifty (1200 nifties) to
get the position:
LONG MTNL Rs.1,000,000
SHORT NIFTY Rs.1,200,000
10 days later, Nifty crashed because of instability
in the government.
On Thursday, Shyam unwound both positions.
His position on MTNL lost Rs.120,000 since
MTNL had dropped to 880,000. His short
position on Nifty June futures earned
Rs.141,600. Overall, he earned Rs.21,600.

Short security Long index futures
Every sell position on a security is a
simultaneous sell position on the index.
A short position on a security must be
accompanied by a long position on the index
futures.
A knowledge of beta is essential.
Illustration
Shyam adopts a position of Rs.1 million SHORT
MTNL on date 1st April 1997. He plans to hold
the position till Thursday the 24th.
The beta of MTNL happens to be 1.2.
Hence he needs a long position of Rs.1.2 million
on the index futures market to totally remove his
Nifty exposure.

On date 1st April 97, Nifty is 980 and the nearest
futures contract (with expiration 24th April) is
trading at about 1000. Hence, each market lot of
the futures (200 nifties) is worth Rs.200,000. To
buy Rs.1.2 million of Nifty, we need to buy 6 lots
(by rounding off to the nearest market lot).
He buys 6 market lots of Nifty (1200 nifties) to get
the position:
SHORT MTNL Rs.1,000,000
LONG NIFTY Rs.1,200,000

20 days later, Nifty rose because of stable
political outlook.
On Thursday, Shyam unwound both positions.
His position on MTNL lost Rs.120,000 since
MTNL had gone up to 1,120,000. His short
position on Nifty April futures earned Rs.93,600.
Overall, he lost Rs.26,400.

Have portfolio short index futures
Every portfolio contains hidden index exposure.
Exposure can be minimized by using index
futures.
Knowledge of beta of the portfolio is essential.
Illustration
On 25 May 2001, Shyam has a portfolio composed of
five securities: ITCHOTEL (100 shares, value Rs.112.00),
ORIENTBANK (200 shares, value Rs.68.25), CIPLA (100
shares, value Rs.847.65), LUPINLAB (200 shares, value
Rs.149.85), and SIEMENS (200 shares, value Rs.237.50).
The total portfolio value is 187,085 and the fi ve
securities have weights (5.98%, 7.29%, 45.31%,
16.02%, 25.40%). Shyam does not want to worry about
budget-related fluctuations from 26 May 2001 till 10
June 2001.

The five securities have the following betas:
ITCHOTEL (beta 0.59), ORIENTBANK (beta
0.90), CIPLA (beta 0.75), LUPINLAB (beta 1.13),
and SIEMENS (beta 1.10). Hence the portfolio
beta works out to (0.0598*0.59 + 0.0729*0.90
+ 0.4531*0.75 + 0.1602*1.13 + 0.2540*1.10)
or 0.90.
For complete hedging he will need to sell futures
worth 0.90 * 187,085, i.e. Rs.168,376.50. On 25
May 2001, Nifty is at 1,122.95. So he decides to
sell 200 Nifties.

Hence Shyam supplements his portfolio with a
short position on the Nifty futures with expiry on
25th JUNE worth Rs.224,590.
On 10 June he buys back futures at a lower
price and ends his hedge (see Table 5.1). His
profits on the futures hedging was Rs.32,010
and his losses on the portfolio were Rs.32,990.
Thus the net loss is Rs. 980. If he had not
hedged, he would have lost 32,990.

Have funds Long index futures
Index futures can be used to hedge against a
rise in the index.
Illustration
Iqbal obtained Rs.5 million on 17 Feb 1998. He made a
list of 14 securities to buy, at 17 Feb prices, totaling Rs.5
million.
At that time Nifty was at 991.70. He entered into a LONG
NIFTY MARCH FUTURES position for 5000 nifties, i.e. his
long position was worth 5,053,600.
From 18 Feb 1998 to 09 March 1998 he gradually
acquired the securities (see Table 5.2). On each day, he
purchased one securities and sold off a corresponding
amount of futures.

On each day, the securities purchased were at a
changed price (as compared to the price prevalent on 17
Feb). On each day, he obtained or paid the markto
market margin on his outstanding futures position, thus
capturing the gains on the index.
By 09 Mar 1998 he had fully invested in all the shares
that he wanted (as of 17 Feb) and had no futures
position left.
The same sequencing of purchases, without the umbrella
of protection of the LONG NIFTY MARCH FUTURES
position, would have cost Rs.249,724 more.

Speculation with Index Futures
Bullish index Long nifty futures
On 1 July 2001, Milan feels the index will rise.
He buys 200 Nifties with expiration date on 31st July
2001.
At this time, the Nifty July contract costs Rs.960 so his
position is worth Rs.192,000.
On 14 July 2001, Nifty has risen to 967.35.
The Nifty July contract has risen to Rs.980.
Milan sells off his position at Rs.980.
His profits from the position are Rs.4000.

Speculation with Index Futures
Bearish index Short nifty futures
On 1 June 2001, Milan feels the index will fall.
He sells 200 Nifties with a expiration date of 26th June
2001.
At this time, the Nifty June contract costs Rs.1,060 so his
position is worth Rs.212,000.
On 10 June 2001, Nifty has fallen to 962.90.
The Nifty June contract has fallen to Rs.990. Milan
squares off his position.
His profits from the position work out to be Rs.14,000.

Index Arbitrage
A strategy designed to profit from temporary
discrepancies between the prices of the stocks
comprising an index and the price of a futures
contract on that index. By buying either the stocks
or the futures contract and selling the other, an
investor can sometimes exploit market inefficiency
for a profit. Like all arbitrage opportunities, index
arbitrage opportunities disappear rapidly once the
opportunity becomes well-known and many
investors act on it.
Index Arbitrage
Index arbitrage can involve large transaction costs
because of the need to simultaneously buy and sell
many different stocks and futures, and so only
large money managers are usually able to profit
from index arbitrage. In addition, sophisticated
computer programs are needed to keep track of
the large number of stocks and futures involved,
which makes this a very difficult trading strategy
for individuals.
Programme Trading
Trading a stock portfolio in a single order

Index Arbitrage
Suppose

i.e

How does one carry index arbitrage?
Cash and Carry arbitrage
| | | |
+ > FV(divs) - T) h(0, S S F

| | | | 0 FV(divs) T) h(0, S S - F > +

Index Arbitrage
TODAY
Buy the component of the index in the
appropriate weights, so that index is
replicated
Borrow the forgoing amount for the
number of days until the delivery date, at
an annual interest rate of r% (h%
annualized)
Sell one futures contract at its current
futures price (F
0
)
Total Cash Flow
Cash Flow
- S
0

+ S
0

0

0

Index Arbitrage
FIRST EX-DIVIDEND DATE
Receive dividends
Lend dividends from t
1
to T

Total Cash Flow

SUBSEQUENT EX-DIVIDEND DATES
Receive dividends
Lend dividends from t2, t3,T

Total Cash Flow
Cash Flow
+ divs
- divs

0

+ divs
- divs
0

Index Arbitrage
ON THE DELIVERY DATE
Offset the futures contract
Sell the stocks
Repay loan and interest
Receive dividends and
interest on dividends
Total Cash Flow

Cash Flow
F0 FT = F0 ST
ST
-S0 h(0,T)S0
EFV(divs)

| | | | 0 FV(divs) T) h(0, S S - F > +

Arbitrage with Index Futures
On 1 August, Nifty is at 1200. A futures contract
is trading with 27 August expiration for 1230.
Ashish wants to earn this return (30/1200 for 27
days).
He buys Rs.3 million of Nifty on the spot market.
In doing this, he places 50 market orders and
ends up paying slightly more. His average cost
of purchase is 0.3% higher, i.e. he has obtained
the Nifty spot for 1204.
He takes delivery of the shares and waits.

While waiting, a few dividends come into his
hands. The dividends work out to Rs.7,000.
On 27 August, at 3:15, Ashish puts in market
orders to sell off his Nifty portfolio, putting 50
market orders to sell off all the shares. Nifty
happens to have closed at 1210 and his sell
orders (which suffer impact cost) goes through
at 1207.
The futures position spontaneously expires on
27 August at 1210 (the value of the futures on
the last day is always equal to the Nifty spot).

Ashish has gained Rs.3 (0.25%) on the
spot Nifty and Rs.20 (1.63%) on the
futures for a return of near 1.88%.
In addition, he has gained Rs.7000 or
0.23% owing to the dividends for a total
return of 2.11% for 27 days, risk free.

Optimal hedge ratio
Hedge ratio represents the ratio of the size of the position
taken in futures contracts to the size of the exposure.
Optimal hedge ratio may differ from 1.
The optimal hedge ratio (h
*
) is given as

o
S
= Standard deviation of change in spot price
o
F
= Standard deviation of change in futures price
= Correlation coefficient between spot price and futures price
Optimal hedge ratio is also termed as Minimum variance
hedge ratio.
F
S
h
o
o
=
*
Optimal hedge ratio
Optimal number of futures contracts is given as
thus:

N
A
= Size of the position being hedged (units)
Q
F
= Size of the futures contracts (units)
N
*
= Optimal number of futures contracts for hedging
F
A
Q
N h
N
*
*
=
Optimal hedge ratio and Beta
Stock index futures can be used to hedge an equity
portfolio.
If the portfolio mirrors the index, a hedge ratio of 1.0 is
appropriate.
When the portfolio does not exactly match the index, beta
from the CAPM can be used to determine the appropriate
hedge. This is as thus

P = Current value of the portfolio
A = Current value of the stocks underlying one futures contract

A
P
N | =
*
Beta Management
Portfolio managers adjust their portfolio betas to reflect
changes in the perceived market risk and return
Bullish expectation increase beta (increase the exposure to the
market)
Bearish expectation decrease beta (decrease the exposure to the
market)

How to adjust beta?
Reduce beta by selling part of an equity portfolio and buy risk less
securities
Increase beta make additional investments on risky equity portfolio
through borrowing/selling risk less securities
Beta Management
Adjust beta by using stock index futures
Sell stock index futures to reduce exposure to
market risk
Buy stock index futures to have additional
exposure to market risk
See illustration
Beta Management
A portfolio manager owns following stocks:

Assume that the spot S&P 500 index is at 1350 and the
S&P 500 futures price is 1357. The manager has invested
$40, 70 and 50 million on the first, second and third stock
respectively, thus making the total investment as $160
million. How can he decrease his portfolios beta to 0.83 or
increase it to 1.66.
Stock Umber of shares Stock price ($) Beta
1 5 million 8 1.2
2 5 million 14 0.9
3 5 million 10 1.1
Beta Management
Decreasing the current beta from 1.0375 to 0.83
Define the current portfolio of equities to be asset 1
and the risk less security to be asset 2. The desired
portfolio beta is 0.83. Thus

Therefore, a portfolio consisting of $128 million (0.80
$160 million) invested in our portfolio of three risky
equities, and $32 million in T bills would create a
portfolio with a beta of 0.83 (0.80 1.0375 + 0.20
0).
0.80 or w )0 w (1 (1.0375) w 0.83
1 1 1
= + =
Beta Management
Size of the position being hedged = $32,000,000
(=$32,000,000 / 1350 = 23703.7 units)
Size of one futures contract = 250
Beta of the portfolio = 1.0375
Optimal number of futures contracts = 98.370355
Interest Rate Futures
Interest Rate Futures
Long term interest futures
T-Bond futures
T-note futures
Short term interest rate futures
T-Bill futures contract
Eurodollars
Indian markets
Futures contract on Notional 91 day T bill
Futures contract on Notional 10 year coupon bearing
bond
Futures contract on Notional 10 year zero coupon bond.
T-Bond Futures
The US Treasury Bond contracts at the CBOT
Contract size
One U.S. Treasury bond having a face value at maturity of $100,000
or multiple thereof and coupon rate being 6%.
Deliverable grades
U.S. Treasury bonds that, if callable, are not callable for at least 15
years from the first day of the delivery month or, if not callable,
have a maturity of at least 15 years from the first day of the delivery
month. The invoice price equals the futures settlement price times a
conversion factor plus accrued interest.
Tick size
1/32 of a point ($31.25/contract)
Contract months
Mar, Jun, Sep, Dec
T-Note Futures (10yrs)
One U.S. Treasury note having a face value at maturity of
$100,000 or multiple thereof.
Deliverable grades
U.S. Treasury notes maturing at least 6 1/2 years, but not more
than 10 years, from the first day of the delivery month.
Tick size
One half of 1/32 of a point ($15.625/contract)
Contract months
Mar, Jun, Sep, Dec
CBOT also trades on 5-yr and 2-yr Treasury note futures

Interest Rate Futures (IRF) in NSE
IRF underlyings in NSE
Notional T Bills (91 day)
Notional 10 year bonds (coupon bearing and
non-coupon bearing)
Trading cycle
The interest rate future contract shall be for a
period of maturity of one year

Expiry day
Interest rate future contracts shall expire on the last
Thursday of the expiry month. If the last Thursday is a
trading holiday, the contracts shall expire on the
previous trading day.
Further, where the last Thursday falls on the annual or
half-yearly closing dates of the bank, the expiry and last
trading day in respect of these derivatives contracts
would be pre-poned to the previous trading day.

Contract size
The permitted lot size for the interest rate
futures contracts shall be 2000. The minimum
value of a interest rate futures contract would be
Rs. 2 lakhs at the time of introduction.
The price steps in respect of all interest rate
future contracts admitted to dealings on the
Exchange is Re.0.01.

Settlement procedure and settlement price
Daily Mark to Market settlement and Final Mark to
Market settlement in respect of admitted deals in
Interest Rate Futures Contracts shall be cash settled by
debiting/ crediting of the clearing accounts of Clearing
Members with the respective Clearing Bank.

All positions (brought forward, created during the day,
closed out during the day) of a F&O Clearing Member in
Futures Contracts, at the close of trading hours on a day,
shall be marked to market at the Daily Settlement Price
(for Daily Mark to Market Settlement) and settled.

All positions (brought forward, created during the day,
closed out during the day) of a F&O Clearing Member in
Futures Contracts, at the close of trading hours on the
last trading day, shall be marked to market at Final
Settlement Price (for Final Settlement) and settled.
Daily settlement price shall be the closing price of the
relevant Futures contract for the Trading day.
Final settlement price for an Interest rate Futures
Contract shall be based on the value of the notional
bond determined using the zero coupon yield curve
computed by National Stock Exchange or by any other
agency as may be nominated in this regard.

Conversion Factor and Invoice
Amounts
The invoice amount, or invoice price, is the amount
the short is paid, should they choose to deliver.
He invoice amount equals the futures settlement
price times a conversion factor plus accrued
interest.

interest Accrued factor Convesrion
price settlement contract Futures size Contract amount Invoice

=
Conversion Factor
Conversion factor
Conversion factor for a given bond is the value of the
bond per dollar/rupee of face value as calculated on
the first day of the delivery month, using an annual
YTM of 6% and semi-annual compounding (T-bond
futures).
Conversion factor (price factor) gives the price of an
individual cash bond such that its YTM on the delivery
day is equal to the notional coupon of the contract.

Accrued Interest
Accrued interest

year half in days of Number
coupon last since days of Number

delivers short that the bonds the of value face
$100,000 on interest coupon Semiannual AI
=
Computing the Conversion Factor
Assume it is the first day of the delivery month,
and calculate the time to maturity of the bond.
Round down this time to maturity to the nearest
three-month period. For example, 18 years and 5.5
months becomes 18 years and 3 months.
If after rounding off the life of the bond is an
integer multiple of semi-annual periods, then the
first coupon is assumed to be paid after 6 months,
otherwise assumed to be paid after 3 months.
Conversion Factor Example I
We are short in a June futures contract and that
today is June 1, 2001. Consider a 7% T-bond that
matures on 15 June, 2029 which is eligible for
delivery under the futures contract.
On June 1, this bond has 28 years and 1.5 months
to maturity. When rounded off to the nearest three
months, we get a figure of 28 years.
The first coupon is then assumed to be paid after
six months
Conversion Factor Example I
The conversion factor is calculated as below:
1348 . 1
100
1036 . 19 3791 . 94

100
) 56 , 3 ( 100 ) 56 , 3 (
2
7
=
+
=
+
=
PVIF PVIFA
CF
Conversion Factor Example II
Instead of the July 2029 bond, consider another
bond that is maturing on 15 September, 2029.
On June 1, 2001, this bond has 28 years and 3.5
months to maturity.
The life of the bond, when rounded off to the
nearest three months, is 28 yrs and 3 months.
First coupon is assumed to be paid after three
months.
Conversion Factor Example II
First the price of the
bond three months
from today, using a
yield 6% is calculated.
Discount the price for
another three months.
Subtract the accrued
interest for three
months, from the price
obtained above.
116.9827 19.1036 94.3791 3.5
) 56 . 3 ( 100 ) 56 , 3 (
2
7
2
7
= + + =
+ + = PVIF PVIFA P
2665 . 115
) 03 . 1 (
9827 . 116
5 . 0
=
1352 . 1
100
75 . 1 2665 . 115
75 . 1
2
1
2
7
=
=
= =
CF
AI
Invoice Price
Let us assume that on 15 June, 2001 the 7%
bond maturing on 15 September, 2029 will
be delivered under June contract.
The actual delivery will be made two days
later, that is, on 17 June.
How to calculate the invoice price?
Invoice Price
The last coupon would have been paid on 15
March, 2001 and the next will be due on 15
September, 2001.
Accrued interest for a T-bond with face value of
$100,000 is
The futures settlement price on 15 June is
assumed to be 95-12.
This corresponds to a decimal futures price per
dollar of the face value of
0435 . 1788 100000
184
94
2
07 . 0
= = AI
95375 . 0
100
32 / 12 95
=
+
Invoice Price
Invoice price
5 110057.743
0435 . 1788 100000 1352 . 1 95375 . 0 Price Invoice
=
+ =
T-Bond Futures Prices
Cost-of-Carry model determines the T-Bond futures
prices.
Because the short gets to choose which bond to
deliver, the futures price will reflect the spot price
(S) of the bond that the market expects the short
to select. This is called Cheapest-to-Deliver (CTD)
bond.
The carry cost (CC) is the interest rate changes
incurred when an trader borrows to buy the CTD.
Carry return (CR) is the accrued interest, actual
coupon payments and the interest on coupons, if
any.
Cheapest to Deliver T-Bond
During the delivery month the CTD is determined
by computing the cost and the invoice amount.
CTD is one that maximizes the inflows and
minimizes the outflows for the short.
CTD = max [invoice amount (spot price + accrued
interest)]
Before the delivery period, we can only estimate
which T-Bond will likely to be the CTD.
Implied repo rate (IRR)
IRR is the rate of return earned by buying the
deliverable spot asset and simultaneously selling a
futures contract. Thus

0
0 0
S
S CR F
IRR
+
=
Using duration
If yields are above 6%, the CTD bond will be the
eligible bond with highest duration.
If yields are below 6%, the CTD bond will be the
eligible bond with the lowest duration.
T-Bill Futures Contracts
Exchange
International Money Market (IMM) segment of
Chicago Mercantile Exchange (CME)
Underlying
3-month US T-bills having a face value at
maturity of $1 million.
Delivery dates
March, June, September and December
Eurodollar Futures
Underlying
3 month time deposits in dollars at banks
located outside the US mainly in Europe and in
particular, in London.
Cash settled

Futures

Diunggah oleh

Informasi Dokumen

Judul Asli

Hak Cipta

Format Tersedia

Bagikan dokumen Ini

Bagikan atau Tanam Dokumen

Opsi Berbagi

Apakah menurut Anda dokumen ini bermanfaat?

Apakah konten ini tidak pantas?

Hak Cipta:

Format Tersedia

Futures

Diunggah oleh

Hak Cipta:

Format Tersedia

Futures

+ > FV(divs) - T) h(0, S S F

+ < FV(divs) - T) h(0, S S F

+ > FV(divs) - T) h(0, S S F

Anda mungkin juga menyukai