Futures Club National Taiwan University Introduction to Futures

Futures Club, National Taiwan University Introduction to Futures and Futures Market Yu Chen-Wen President of the Futures Club, National Taiwan University Department of International Business All Rights Reserved by the author The Information on this file may not be reproduced, republished or mirrored without permissions

Futures Club, National Taiwan University Main Concept - Derivatives • A financial instrument whose value depends on (or derives from) the value of other, more basic underlying asset. • e. g : Futures, Options, Mortgageback securities.

Futures Club, National Taiwan University What is Futures? ? • Forward contract is an agreement to buy or sell an asset at a certain futures time for a certain price. example: • Futures contract is alike forward contract, but normally trade on an exchange. example:

Futures Club, National Taiwan University Terminology in Futures Market & How Could We Trade Futures in Taiwan • Lot • Position • Liquidation, Offset • Delivery • Open Interest • Margin Call • Settlement Price

An Instance of Futures Market Futures Club, National Taiwan University • Three investors, A, B and C. • On Oct. 10, 2004, A long a TAIEX futures for NT 1, 000(5000 index point * NT 200 per index point) which delivery month is Jan. 2005 and investor B is the opposite side of this contract. • On Nov. 20, the Taiwan Stock Exchange Capitalization Weighted Stock Index is 4500 point. • On Dec. 5, B want to offset the position. The TAIEX futures which has the same delivery month is NT 900, 000 on that day. • On Dec. 15, investor C short a TAIEX futures for NT 920, 000 which delivery month is Jan. 2005. • On the third Wednesday of the Jan, 2005. Cash settlement occur. TAIEX is 5200 point.

Futures Club, National Taiwan University Comparison of forward and futures contracts • Forward Contract • Futures Contract a) b) c) Trade on over-the counter market Not standardized Usually one specified delivery date Settle at the end of contract Delivery or final cash settlement usually take place a) b) c) d) e) Trade on an exchange Standardized contract Range of delivery dates Settled daily Contract is usually close out prior to maturity d) e)

Futures Club, National Taiwan University Question: why people need futures? ? • Hedgers • Speculators • Arbitrageurs Type of Trader

Futures Club, National Taiwan University Futures Market • CBOT(Chicago Board of Trade) • London International Financial Futures and Options Exchange • SIMEX(The Singapore Exchange) • TAIFEX(Taiwan Futures Exchange)

Futures Club, National Taiwan University The Growth in Futures Market (TAIEX) Source: TAIEX Website http: //www. taifex. com. tw

Futures Club, National Taiwan University Futures Category In TAIEX I. TAIEX Futures II. Electronic Sector Index Futures III. Finance Sector Index Futures IV. Mi. Ni-TAIEX Futures V. Taiwan 50 Futures VI. 10 -year Government Bond Futures VII. 30 -Day Commercial Paper Interest Rate Futures

Futures Club, National Taiwan University Futures Category (con’t) Others I. MSCI Taiwan Index Futures II. CBOT mini-sized Silver Futures III. Corn Futures IV. 10 Year U. S. Treasury Notes Futures V. CBOT Dow Jones U. S. Total Market Index Futures (TMI)

Futures Club, National Taiwan University Relationship Between Futures Price and Spot Price Futures price are above spot price Futures price are below spot price

*Selective Topic Futures Club, National Taiwan University Determination of Forward and Futures Price Asset Forward/Futures Price Value of long forward contract with delivery price K Provide no Income S 0 er. T S 0 – Ke-r. T Provide known income with present value I (S 0 – I)er. T S 0 – I – Ke-r. T S 0 e(r-q)T S 0 e-q. T – Ke- r. T Provide known yield q T: Time until delivery date in a forward or futures contract (in years) S 0: Price of the asset underlying the forward or futures contract today F 0: forward or futures contract price today r: Risk-free rate per annum, expressed with continuous compounding K: delivery price in the contract

Futures Club, National Taiwan University Determination of Forward and Futures Price In Reality The only determinant is “Demand & Supply”!!!! We could to draw support from Technical Analysis

*Selective Topic Futures Club, National Taiwan University Hedge Strategies Using Futures • Minimum Variance Hedge Ratio h* = ρ (σS / σF) σS: Standard deviation of the change in spot price σF: : Standard deviation of the change in futures price ρ: Coefficient of correlation between the change in spot and futures price h*: Hedge ratio that minimize the variance of the position

*Selective Topic Futures Club, National Taiwan University Hedge Strategies Using Futures(con’t) • Optimal Number of Contract N* = [(h*NA) / QF] NA: Size of position being hedge(unit) QF: Size of futures contract N*: Optimal number of futures contracts for hedging h*: Hedge ratio that minimize the variance of the position

Futures Club, National Taiwan University Case Discussion • “Speculation in futures market is pure gambling. It’s not in the public interest to allow speculator to trade on futures exchange. ” Do you agree this statement? ? • Consider a three-month TAIEX futures, suppose that the underlying index provides a dividend yield 1% per annum. The current index point is 5800 and the risk-free interest rate is 5%. How much this futures worth? ?

Futures Club, National Taiwan University Reference §TAIEX, http: //www. taifex. com. tw/ §CBOT, http: //www. cbot. com/ §TSEC, http: //www. tse. com. tw/ §“Futures, Options, and Other Derivatives 5 edition” John Hull, Prentice Hall §“Technical Analysis of Financial Market” John J. Murphy, New York Institute of Finance