Aff9150
Outline
Example of a forward contract
AFF9150 Lecture 2: Forwards and Futures
Binh Do
Futures Standardized Contract Terms Unilateral Reversal of Positions
Required reading: Sundaram and Das – Ch 1 (pp5-9) & Ch 2
Default Risk and Margin Accounts
Case Study: Metallgesellschaft AG
1
2
What is a forward contract?
Payoff to a forward contract
•
A private agreement between two parties, a buyer and a seller, that calls for delivery of an asset at a future date with a price agreed upon today (“forward price”) Example: On 1/3/12, a buyer and a seller enters a forward contract on 5000 ANZ shares (the underlying) at $22 (forward) for settlement on 30/6/12 (expiration/delivery date). Price for ANZ share on 1/3/12 is $21 (spot price)
•
Assuming the actual price for ANZ share on 30/6/12 is $23. The buyer receives the shares and pay the seller $22/share, thus making a profit of (23-22)*5000 =$5000 If the actual price on 30/6/12 is $20 instead, the buyer still takes delivery of the shares and pay $22/share, thus incurring a loss of (22-20)*5000=10,000 The above is physical settlement: buyer takes delivery from seller and pays the forward price. Alternatively, the contract may require cash settlement: upon settlement, the losing party simply pays the other the difference. Economic outcomes are largely the same under both methods
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3
Payoff function and payoff diagram to a long forward contract
Payoff function and payoff diagram to a short forward contract
Payoff ST F0
Payoff diagram
Payoff function: ST –F0
Profit
Payoff function: F0 –ST
ST F0
Payoff diagram
6
A payoff function expresses the value of a position at maturity, as a function of the underlying variable ST A payoff diagram graphs the payoff function, showing value of a position at different possible values of ST 5
Credit risk/Counterparty risk in a forward contract
• There is possibility that the party who’s sitting
Example of a forward contract
AFF9150 Lecture 2: Forwards and Futures
Binh Do
Futures Standardized Contract Terms Unilateral Reversal of Positions
Required reading: Sundaram and Das – Ch 1 (pp5-9) & Ch 2
Default Risk and Margin Accounts
Case Study: Metallgesellschaft AG
1
2
What is a forward contract?
Payoff to a forward contract
•
A private agreement between two parties, a buyer and a seller, that calls for delivery of an asset at a future date with a price agreed upon today (“forward price”) Example: On 1/3/12, a buyer and a seller enters a forward contract on 5000 ANZ shares (the underlying) at $22 (forward) for settlement on 30/6/12 (expiration/delivery date). Price for ANZ share on 1/3/12 is $21 (spot price)
•
Assuming the actual price for ANZ share on 30/6/12 is $23. The buyer receives the shares and pay the seller $22/share, thus making a profit of (23-22)*5000 =$5000 If the actual price on 30/6/12 is $20 instead, the buyer still takes delivery of the shares and pay $22/share, thus incurring a loss of (22-20)*5000=10,000 The above is physical settlement: buyer takes delivery from seller and pays the forward price. Alternatively, the contract may require cash settlement: upon settlement, the losing party simply pays the other the difference. Economic outcomes are largely the same under both methods
4
•
•
•
•
•
3
Payoff function and payoff diagram to a long forward contract
Payoff function and payoff diagram to a short forward contract
Payoff ST F0
Payoff diagram
Payoff function: ST –F0
Profit
Payoff function: F0 –ST
ST F0
Payoff diagram
6
A payoff function expresses the value of a position at maturity, as a function of the underlying variable ST A payoff diagram graphs the payoff function, showing value of a position at different possible values of ST 5
Credit risk/Counterparty risk in a forward contract
• There is possibility that the party who’s sitting