Ch. 21 isk Management o 2002. Prentice Hall. Inc
© 2002, Prentice Hall, Inc. Ch. 21: Risk Management
Innovations in Risk Management Futures contract: a contract to buy or sell a stated commodity or financial claim at a specified price at some specified future time
Innovations in Risk Management • Futures contract: a contract to buy or sell a stated commodity or financial claim at a specified price at some specified future time
Futures: a simple example Suppose a farmer plans to harvest 10.000 bushels of corn in 6 months The current price is $2.50 per bushel. The farmer sells a futures contract which will allow him to sell corn at 2.50 per bushel in 6 months If the price of corn falls to $2. 00 per bushel, the farmer loses $5, 000 (S050x 10,000 bushels )on his corn, but gains $5,000 on his futures contract
Futures: a simple example • Suppose a farmer plans to harvest 10,000 bushels of corn in 6 months. The current price is $2.50 per bushel. The farmer sells a futures contract, which will allow him to sell corn at 2.50 per bushel in 6 months. • If the price of corn falls to $2.00 per bushel, the farmer loses $5,000 ($0.50 x 10,000 bushels) on his corn, but gains $5,000 on his futures contract
Futures: a simple example If the price of corn rises to $3.00 per bushel, the farmer gets s5,000 more for his corn, but loses s5.000 on the futures contract The farmer has effectively locked in a price of $2.50 per bushel and has hedged his risk
Futures: a simple example • If the price of corn rises to $3.00 per bushel, the farmer gets $5,000 more for his corn, but loses $5,000 on the futures contract. • The farmer has effectively locked in a price of $2.50 per bushel and has hedged his risk
Futures Trading requires: An Organized Exchange -the Chicago board of Trade is the oldest and largest futures exchange. Standardized contracts - for more frequent trades and greater liquidity
Futures Trading Requires: • An Organized Exchange - the Chicago Board of Trade is the oldest and largest futures exchange. • Standardized Contracts - for more frequent trades and greater liquidity
Futures Trading requires: A Futures Clearinghouse-stands between all buyers and sellers to quarantee that all trades are honored Daily resettlement of Contracts -An initial margin of 3 to 10%o of the contract's value is paid up front. A maintenance margin is required. Any end-of-day losses must be replenished by the contract holder
• A Futures Clearinghouse - stands between all buyers and sellers to guarantee that all trades are honored. • Daily Resettlement of Contracts - An initial margin of 3% to 10% of the contract’s value is paid up front. A maintenance margin is required. Any end-of-day losses must be replenished by the contract holder. Futures Trading Requires:
Types of futures Contracts Commodity Futures- agricultural commodities(corn, wheat, orange juice, etc. )as well as metals, wood products and fibers. Financial futures futures contracts on Treasury bills, notes and bonds, GNMAS。CDS Eurodollars, foreign currencies, and stock indices
Types of Futures Contracts • Commodity Futures - agricultural commodities (corn, wheat, orange juice, etc.) as well as metals, wood products and fibers. • Financial Futures - futures contracts on Treasury bills, notes and bonds, GNMAs, CDs, Eurodollars, foreign currencies, and stock indices
Financial futures Interest Rate Futures- used to hedge risks associated with interest rate fluctuations For example, Treasury bond futures may allow a firm to lock in an interest rate for their bond issue
Financial Futures • Interest Rate Futures - used to hedge risks associated with interest rate fluctuations. • For example, Treasury bond futures may allow a firm to lock in an interest rate for their bond issue
Financial futures Foreign Exchange futures used to hedge risks associated with exchange rate fluctuations A firm can use a foreign exchange futures contract to lock in an exchange rate for a future transaction
• Foreign Exchange Futures - used to hedge risks associated with exchange rate fluctuations. • A firm can use a foreign exchange futures contract to lock in an exchange rate for a future transaction. Financial Futures
Financial futures Stock Index futures- used to hedge risks associated with equity market fluctuations. Investors can buy and sell contracts based on the s&p 500 and other market indices
• Stock Index Futures - used to hedge risks associated with equity market fluctuations. • Investors can buy and sell contracts based on the S&P 500 and other market indices. Financial Futures
