Lecture 4: Introduction to Futures Markets

Transcription

1 Lecture 4: Introduction to Futures Markets Tanweer Akram, PhD Jan 23, 2018, SANEM, Dhaka, BANGLADESH 0

2 IMPORTANT DISCLAIMER AND DISCLOSURE Disclaimer: The author s institutional affiliation is provided solely for identification purposes. Views expressed are solely those of the author and the standard disclaimer applies. The views are not necessarily those of Thrivent Financial, Thrivent Investment Management, or any affiliates. This is for information purposes only and should not be construed as an offer to buy or sell any investment product or service. Disclosure: Tanweer Akram s employer, Thrivent Financial, invests in a wide range of securities. Asset management services are provided by Thrivent Asset Management, LLC, a wholly owned subsidiary of Thrivent Financial for Lutherans. Compliance Tracking #

3 INTEREST RATE FUTURES Spot transaction Forward transaction Example of a farmer using a forward transaction. Why? To reduce uncertainty, hedge risks, and to lock in a price. Benefits of future markets: More participants Higher trading volume Hedging 2

4 BASICS OF FUTURES TRANSACTION Forward market Future market brings standardization Interest rate futures Equity futures Large exposure with little cash The standardization of future contracts => Consistency Clearing house and counter party risks. A clearing house clears trade between parties (buyers/sellers). Cash settle contracts. Price of forward contracts (P FC ) = Current price of Asset (P A ) Net cost of holding (h) If P FC >(P A h) then sell forward contract and buy asset. If P FC <(P A h) then sell asset and buy forward contract. 3

5 FUTURES IN FIXED INCOME SPACE Eurodollar future Treasury futures Fed funds futures 4

6 EURODOLLAR FUTURES Eurodollar time deposits are overseas deposit of US$. Eurodollar futures enable investors to take a view on interest rates on euro dollar deposits Eurodollar futures are standardized products. Notional $1 million. 3 month contract. 3 month LIBOR. Interest rate = 100 Price. Quarterly settlement. 1 basis point change in price profit/loss of $25. Example; If interest rate rises from 3.00% to 3.01%, contract seller gains $25, buyer loses $25. If interest rate declines from 3.00% to 2.99% contract seller loses $25, buyer gains $25. If investor expects inflation to rise, she will sell eurodollar futures to gain from rising interest rate. 5

7 EURODOLLAR FUTURES During banking stress, usually LIBOR rises, or the LIBOR-OIS spread rises. Relationship between long rates, short rates, and forward rates: (1+R L xdays 1 /360)=(1+R S xdays 2 /360)(1+FxDays 3 /360) F={[(1+R L xdays 1 /360)/(1+R S xdays 2 /360)]-1}x360/Days 3 LIBOR = London Interbank Offer Rate OIS = Overnight Index Swaps 6

8 CONVEXITY BIAS (OR FINANCING BIAS) Forward rates from FRA (forward rate agreement) and eurodollar contracts can diverge over the long-term due to convexity bias. For eurodollar futures there is no convexity in payoffs. Eurodollar rate is slightly higher (and price lower) for an equivalent FRA. Financing bias depends on the volatility of interest rate. 7

9 CREATING LONGER DATED ASSETS USING EURODOLLAR FUTURES Eurodollar contracts needs not be confined to 3 month terms. Possible to combine eurodollar contracts. A strip of eurodollar. Strip rate Packs: (1) White pack, (2) Red pack, and (3) Green pack. White pack is the group of first four contracts, red pack is the group of four contracts after the first four, and green pack is the next group of four contracts. Red pack provides 1yr,1yr forward rate, while Green pack provides 2yr,1yr forward rate. 8

10 TREASURY FUTURES Allow investors to buy/sell Treasury securities at a given price on a forward date. Settled on a physical basis. Actual delivery of Treasury securities rather than cash P/L. Seller has a choice on which bonds to deliver. Quarterly basis. 2 yr, 5 year, 10 yr, & 30 yr futures. TU 2Yr, FV 5 yr, TY 10 yr, and US 30 yr. Notional: $100K, but 2 Yr, notional $200K. Ticks and half ticks. 9

11 FED FUNDS FUTURES Fed Fund Future Market Fed funds target rate Fed funds effective rate A short-term rate Interest rate = 100 Price Monthly contracts Settled on the basis of average daily fed funds effective rate Fed funds effective rate trades lower than 3M LIBOR 10

12 CHICAGO MERCHANTILE EXCHANGE (CME) MONTHLY SYMBOLS Source: Jha (2011) 11

13 CME FUTURES CODES Source: Jha (2011) 12

14 FUTURES POSITIONING DATA Commercial A/C Noncommercial A/C 13

15 SUMMARY: INTEREST RATE FUTURES Three main U.S. interest rates future contracts Eurodollar futures U.S. Treasury futures Fed funds futures 14