Page 57 - DCOM510_FINANCIAL_DERIVATIVES

Financial Derivatives

Notes

Task Do you think that a web-enabled foreign exchange market would revolutionise the
forex trading practices in the future? Elucidate with examples.

Self Assessment

State whether the following statements are true or false:
6. The value of the futures contract is ‘settled’ (i.e., paid or received) at the end of each trading
day.
7. A forward contract is an exchange-traded contract.
8. The organisation of futures trading with a clearing house reduces the default risks of
trading.

4.3 Futures Terminology

The important terminologies used in future contracts are described below:

Spot price: The price at which an underlying asset trades in the spot market.
Futures price: The price that is agreed upon at the time of the contract for the delivery of an
asset at a specific future date.

Contract cycle: It is the period over which a contract trades.
!

Caution The index futures contracts on the NSE have one-month, two-month and three-
month expiry cycles which expire on the last Thursday of the month.
Thus, a January expiration contract expires on the last Thursday of January and a February
expiration contract ceases trading on the last Thursday of February. On the Friday following the
last Thursday, a new contract having a three-month expiry is introduced for trading:
Expiry date: It is the date on which the final settlement of the contract takes place.
Contract size: The amount of asset that has to be delivered for one contract. This is also
called as the lot size.
Basis: Basis is defined as the futures price minus the spot price. There will be a different
basis for each delivery month for each contract. In a normal market, basis will be positive.
This reflects that futures prices normally exceed spot prices.
Cost of carry: Measures the storage cost plus the interest that is paid to finance the asset
less the income earned on the asset.

Initial margin: The amount that must be deposited in the margin account at the time a
futures contract is first entered into is known as initial margin.

Marking-to-market: In the futures market, at the end of each trading day, the margin
account is adjusted to reflect the investor’s gain or loss depending upon the futures closing
price. This is called marking-to-market.

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