Page 45 - DMGT513_DERIVATIVES_AND_RISK_MANAGEMENT

Derivatives & Risk Management

Notes 2. The shares selected must correspond to the set of shares used to create the index.
3. The amount of each holding must be in proportion to the market capitalisation of the
companies.

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Caution The profit or loss from a futures contract that is settled at delivery is the difference
between the value of the index at delivery and the value when originally purchased or
sold. It is important to emphasise that the delivery at settlement cannot be in the underlying
stocks but must be in cash. The futures index at expiration is set equal to the cash index on
that day.

4.2.2 Commodity Futures

The commodity futures include:
1. Agricultural futures contracts: These contracts are traded in grains, oil and meal, livestock,
forest products, textiles and foodstuff. Several different contracts and months for delivery
are available for different grades or types of commodities in question. The contract months
depend on the seasonality and trading activity.
2. Metallurgical futures contract: This category includes genuine metal and petroleum
contracts. Among the metals, contracts are traded on gold, silver, platinum and copper. Of
the petroleum products, only heating oil, crude oil and gasoline are traded.

4.2.3 Currency Futures

Currency future is the price of a particular currency for settlement at a specified future
date. Currency futures are traded on future exchanges and the exchanges where the contracts
are fungible (or transferable freely) are very popular. The two most popular future
exchanges are the Singapore International Monetary Exchange (SIMEX) and the International
Money Market, Chicago (IMM). Other exchanges are in London, Sydney, Frankfurt, New York,
Philadelphia, etc.

The first exchange-traded foreign currency futures contracts were launched on the
International Monetary Market (IMM) – now part of the Chicago Mercantile Exchange (CME)
– in 1972. Seven currencies were traded and others have since been added. The CME remains
the most active market in these contracts to this day, though a number of other exchanges
have launched their own contracts. The figure 4.1 shows the monthly price chart of CME
British Pound.
Today, there are financial futures on debt instruments called interest rate futures, foreign
exchange rate called currency futures and stock market averages called stock index futures.
Financial futures are different from commodity futures in several ways. The most important
difference is that many financial futures are not deliverable. The fact that very few contracts
are actually delivered led many exchanges to consider eliminating the delivery feature all
together. Till date this has not happened in commodity futures, but many financial futures
are created as non-deliverable instruments. Stock index futures and interest rate
futures are such futures. In place of delivery, these contracts are cash settled on specific final
delivery dates. Badla trading in India was the predecessor of futures and forwards
trading.

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