Fabozzi Chapter 26

Front 1

What is the basic economic function of futures markets?

Back 1

to hedge against the risk of adverse price movements

Front 2

What are commodity futures?

Back 2

1. traditional agricultural commodities (grain and livestock)
2. imported foodstuffs (coffee, cocoa, sugar)
3. industrial commodities

Front 3

What are financial futures?

Back 3

1. stock index futures
2. interest rate futures
3. currency futures

Front 4

What are futures contracts commonly called?

Back 4

derivative instruments; derives value from the value of the underlying instrument

Front 5

What is a futures contract?

Back 5

a legal agreement between a buyer and a seller in which:
1. buyer agrees to take delivery of something at a specified price at the end of a designated period of time
2. seller agrees to make delivery of something at a specified price at the end of a designated period of time

Front 6

What is the futures price?

Back 6

price at which the parties agree to transact in the future

Front 7

What is the settlement or delivery date?

Back 7

the designated date at which the parties must transact

Front 8

What is the underlying?

Back 8

the "something" that the parties agree to exchange

Front 9

What is long position or long futures?

Back 9

when an investor takes a position in the market by buying a futures contract; wants futures price to increase to realize a profit

Front 10

What is short position or short futures?

Back 10

when an investor's opening position is the sale of a futures contact; wants the futures price to fall to realize a profit

Front 11

What is a nearby futures contract?

Back 11

contract with the closest settlement date (settlement dates are usually in March, June, September or December)

Front 12

What is the most distant (or deferred) futures contract?

Back 12

the contract farthest away in time from settlement

Front 13

What two choices does a party to a futures contract have regarding liquidation of the position?

Back 13

1. liquidate prior to the settlement date; party must take an offsetting position in the same contract; if a buyer, must sell identical number of contracts, vice versa
2. wait until the settlement date; or cash settlment

Front 14

What are cash settlement contracts?

Back 14

futures contract in which settlement is made in cash only

Front 15

What is a contract's open interest?

Back 15

statistic that measures the liquidity of contract; it's the number of contracts that have been entered into but not yet liquidated

Front 16

What is the clearinghouse?

Back 16

1. guarantees the two parties to the transaction will perform; clearinghouse takes the opposite position and agrees to satisfy the terms set forth in the contract
2. allows parties to a future contact to unwind their position prior to the settlement date

Front 17

What is initial margin?

Back 17

when a position is first taken in a futures contract, the investor must deposit a minimum dollar amount per contract, specified by the exchange; may be a Treasury bill

Front 18

What is investor's equity?

Back 18

sum of all the margins posted and all daily gains less all daily losses to the account

Front 19

What is the settlement price?

Back 19

not the closing price, value that the exchange considers to be representative of trading at the end of the day

Front 20

What is maintenance margin?

Back 20

minimum level to which an investor's equity position may fall as a result of an unfavorable price movement before the investor is required to deposit additional margin

Front 21

What is variation margin?

Back 21

amount necessary to bring the equity in the account back to its initial margin level; must be in cash rather than interest-bearing instruments; must be posted within 24 hrs

Front 22

What are the two types of floor traders?

Back 22

1. locals- buy and sell futures contracts for their own account, risk their own capital; professional risk takers; bring liquidity to the market; play same role as market maker- there is no actual market maker
2. floor brokers (or pit brokers)- buy and sell for their own account; execute customer orders as well; mostly trade for customers

Front 23

What is a futures commissions merchant?

Back 23

an authorized futures broker; go through to floor brokers to be executed

Front 24

What is a daily price limit?

Back 24

sets the minimum and maximum price at which the futures contract may trade at that day; provides stability

Front 25

What is a forward contract?

Back 25

like a futures contract, it is an agreement for the future delivery of something at a specified price at the end of a designated period of time; however futures contracts are standardized- as to delivery date and quality, forward contracts is nonstandardized, terms are negotiated individually between buyer and seller; no clearinghouse and secondary markets are either thin or nonexistent; futures are exchange traded and forwards are over-the-counter instruments; less than 2% of outstanding futures contracts are settled by delivery; forward contracts are intended for delivery; forward contracts are exposed to credit risk, either party may default;

Front 26

How is the dollar value of a stock index future calculated?

Back 26

dollar value of a stock index futures contract = futures price X multiple

Front 27

What are the types of financial futures markets in the US?

Back 27

1. stock index futures - cash settlement contracts
2. interest rate futures markets- T-bill futures (13 week remaining to maturity, $1 million face value); Eurodollar CD Futures; Treasury note futures; Agency Futures Contract; Bond Buyer's Municipal Bond Index Futures

Front 28

What are conversion factors?

Back 28

the factor that must be multiplied by the price of the futures contract to arrive at the invoice price for a particular deliverable Treasury bond or note

Front 29

What is the cheapest-to-deliver issue?

Back 29

the Treasury issue that is the cheapest to deliver to satisfy the delivery requirements of a Treasury bond or Treasury note futures contract

Front 30

What is the quality or swap option?

Back 30

the option granted to the short of a Treasury bond futures contract to select the Treasury issue to deliver

Front 31

What is the timing option?

Back 31

the short position is permitted to decide when in the delivery month actually to make the delivery

Front 32

What is the wild card option?

Back 32

the right of the short position to give notice of intent to deliver after the closing of the exchange, on the date when the futures settlement price has been fixed

Front 33

What is a forward rate agreement (FRA)?

Back 33

over-the-counter equivalent of the exchange traded futures contracts on short-term rates; buyer of an FRA benefits if the reference rate (interest rate) increases, unlike futures contract in which buyer benefits when rate declines; this is because in FRA the underlying is a rate and in futures contract the underlying is a fixed-income instrument; in FRA, one party pays a fixed rate and the other pays a floating rate; so person paying the fixed rate (the buyer) hopes the reference rate increases