Page 125 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

International Financial Management

Notes Self Assessment

State whether the following statements are true or false:
1. Stock index futures do not permit investment in the stock market without the trouble and
expense involved in buying the shares themselves.

2. 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.
3. A option index futures contract is a contract to buy or sell the face value of the underlying
stock index where the face value is defined as being the value of index multiplied by the
specified monetary amount.

4. A futures contract represents a contractual agreement to purchase or sell a specified asset
in future for a specified price that is determined today.

8.2 Mechanism of Futures Trading

The mechanics of futures trading consists of two parts.

Components of Futures Trade

The components of futures trade are described below:
(i) Futures Players: Futures trading, which represents a less than zero-sum game, can be
considered beneficial if it results in utility gains. This is done by the transfer of risks
between the market players. These players are: Hedgers, Speculators and Arbitrage
(ii) Clearing Houses: Every organised futures exchange has a clearing house that guarantees
performance to all of the participants in the market. It serves this role by adopting the
position of buyer to every seller and seller to every buyer. Thus, every trading party in the
futures markets has obligations only to the clearing house. Since the clearing house matches
its long and short positions exactly, it is perfectly hedged, i.e., its net futures position is
zero.
It is an independent corporation and its stockholders are its member clearing firms. All
futures traders maintain an account with member clearing firms either directly or through
a brokerage firm.
(iii) Margin Requirements: Each trader is required to post a margin to insure the clearing house
against credit risk. This margin varies across markets, contracts and the type of trading
strategy involved. Upon completion of the futures contract, the margin is returned.

(iv) Daily Resettlement: For most futures contracts, the initial margins are 5% or less of the
underlying commodity’s value. These margins are marked to the market on a daily basis
and the traders are required to realise any losses in cash on the day they occur. Whenever
the margin deposit falls below minimum maintenance margin, the trader is called upon
to make it up to the initial margin amount. This resettlement is also called marked-to-the-
market.
Delivery Terms: This includes:
(a) Delivery Date: Some contracts may be delivered on any business day of the delivery
month while others permit delivery after the last trading day.
(b) Manner of Delivery: The possibilities are:
Physical exchange of underlying asset.

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