Alternative methods of weighting

It is generally considered that capitalization weighted indices give the most accurat indication of the collective movement in corporate asset or liability prices. However two alternative methods of weighting the constituents of equity indices are fowl^,‘equally weighted‘ and ‘price weighted‘. In the case of equally weighted indices, a’ equal amount of money is assumed to be invested in each security in the index Changes in the index thus represent changes in the value of the portfolio. Pri weighted indices reflect the average price of the securities in the index and Chang: in the index represent the average price change of the securities in the index. The Dow—Jones and the Major Market Index of the American Stock Exchange (MMI) a. both of the price weighted form. The FT 30 is a geometric average equally weight index. Only the Major Market Index has a futures contract based upon it. Read more »

Posted: June 28th, 2008 under Commodities Futures, Foreign Exchange Futures, Future Management, Futures Contracts, Futures Trading System, Managed Futures, Short Futures, Stock Futures, investment.
Comments: 6

The Black model should not be used for valuing American options on currency futures because it may be optimal to exercise the options early in the same way as it may be optimal to exercise options on the spot currency early. The binomial or the Barone-Adesi and Whaley models may be used for valuing those options.

The early exercise potential of American options on futures is different to that of options on the spot. Futures prices do not exhibit the discrete jumps that accompany spot market assets when the underlying spot asset makes discrete distributions. However, as the carry basis of the future converges to zero at delivery, the futures price converges to the spot price in an orderly manner. Read more »

Posted: June 22nd, 2008 under Currency Futures, Futures Options, Futures Prices, Swap Futures, investment.
Comments: 4

As with all other forms of futures contract, the fair price of short-term interest rate futures should preclude any arbitrage possibilities between the futures market and the underlying cash market. In the case of bank deposit interest rate futures, there should be no arbitrage possibilities between the forward interest rate implied by the future and the forward interest rate available on the appropriate type of bank deposit. For example, a three-month eurodollar futures contract that has 135 days to maturity should not provide any arbitrage possibility with the 135-day forward rate on a three-month eurodollar deposit. Read more »

Posted: June 20th, 2008 under Future Trading, Futures Contracts, Futures Market, Futures Prices, Interest Rate Futures.
Comments: 5

It was shown that it is possible to lock in a forward rate of interest. However, depositors will only lock in a forward deposit if the rate that results is at least as favourable as the rate that they expect to prevail at the future point in time. If the forward rate implied by the current rates was above investors’ expectations, theinvestors would increase their borrowing for 90 days, causing upward pressure on that rate, and increase their deposits for 180 days, causing downward pressure on that rate, thereby bringing the 90-day forward rate down to current expected levels.

Conversely, if the implied forward rate were below expectations, investors would borrow for the longer term, raising that rate, and deposit for the shorter term, lowering that rate, until the implied forward rate matched expectations. Read more »

Posted: June 20th, 2008 under Future Exchange, Futures Contracts, Futures Market, Futures Prices, Interest Rate Futures.
Comments: 6

The valuation of interest rate options is currently the most contested area of option- pricing theory. The problem stems from the fact that although there is a reasonable consensus about the nature of the stochastic process of share prices, equity indices and currencies, the movements in interest rates and interest rate dependent instruments are not fully understood and full agreement on the underlying process has yet to be reached.

The stochastic process of interest rates, and therefore the prices of interest rate dependent claims, has proved to be very difficult to model for a number of reasons. Read more »

Posted: June 17th, 2008 under Equity Futures, Future Broker, Futures Contracts, Futures Quotes, Managed Futures, Stock Market Futures, Swap Futures.
Comments: 4

Bonds are frequently purchased to fund future liabilities because of the relative certainty of the cash flows which are set contractually. However, the certainty as to the value of the terminal value of those future cash flows depends upon two factors:

the rate at which the future coupons can be reinvested remaining unchanged;

if the bond has a maturity longer than the desired holding period, the level of interest rates is the same at the beginning and end of the holding period. Read more »

Posted: June 17th, 2008 under Crude Oil Futures, Futures Options, Futures Prices, Futures Spreads, Short Futures, Silver Futures.
Comments: 6

Key Points

• When currencies are exchanged for delivery more than two business days later, the governing exchange rate is the forward rate. The forward rate is given by an inviolable interest rate parity that ensures that two riskless investments generate the same total return. Under normal circumstances, the forward rate should be an unbiased predictor of the future spot rate. However, the actual future spot rate is significantly different from the forward rate. This phenomenon is referred to as the forward rate bias.
• In order to satisfy the requirement of the same return generated by two riskless assets given by interest rate parity, the currency with the higher interest rate must depreciate relative to a currency with a lower interest rate as given by the forward rate. Evidence indicates that the currency with the higher interest rate actually appreciates instead of depreciating. This pattern is confirmed for a variety of currency pairs not including high-interest-rate currencies, for many different observation periods, and many different holding periods. It seems that the bias decreased a little during the 1990s and it disappears when the holding period becomes about ten years. However, the bias at short holding periods of about one month is of most interest to investors.

Read more »

Posted: February 14th, 2008 under Currency Futures.
Comments: 4

Normal Backwardation

Remember that investors do not like risk, and that they will take a risk only if they think they will be properly rewarded for bearing the risk. If the futures price is what people think the cash price will be at delivery time, why would anyone be interested in speculating? It seems that the hedger can get rid of the price risk without any cost and that the speculator agrees to take the risk off the hedger’s back for nothing. This seems improbable in real life. Read more »

Posted: February 2nd, 2008 under Futures Contracts, Futures Market, Futures Prices.
Comments: 4

In considering what makes a futures contract valuable and what makes the price of the contract fluctuate from day to day, it is important to remember that a futures contract is a promise to exchange certain goods at a future date. You must keep your part of the promise unless you get someone to take the promise off your hands (that is, you make a closing transaction). The promised goods are valuable now, and their value in the future may be more or less than their current worth. Prices of commodities change for many reasons, such as new weather forecasts, the availability of substitute commodities, psychological factors, and changes in storage or insurance costs. These factors all involve shifts in demand for a commodity, changes in the supply of the commodity, or both. Read more »

Posted: February 2nd, 2008 under Futures Contracts, Futures Market, Futures Prices, Interest Rate Futures.
Comments: 3

Development of Derivatives in the UK

The history of derivatives in the UK can be dated back to the arrival of the first centralised commodities market, founded in 1565 by Sir Thomas Greshamand opened by Queen Elizabeth I. It was based in the Royal Exchange (which in 1982 became the first home to the London International Financial Futures Exchange, Liffe) and was run along similar lines to the Amsterdam Trade Centre in the Netherlands, which had opened a few years earlier. Each commodity had a different part of the Exchange from which to trade. Despite the Great Fire in 1666, during which the Exchange building burnt down, commodity trading flourished in the City taking to the coffee houses, while the Royal Exchangewas being rebuilt. Read more »

Posted: January 26th, 2008 under Future Exchange, Future Trading, Futures Market, Futures Prices.
Comments: 4