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2. Forward Contract (cont’d)
B.
Payoff structure
i.^
PF
= forward price for asset X
ii.^
PS
= spot price for asset X at the time when the forward contract
expires
iii. Profit =
P
SALE
-^
PPURCHASE
iv.
If you sign a forward contract to
buy
asset X at price
P
:
Topic 7, page 22
ECO 350 • Money and Banking
iv.
If you sign a forward contract to
buy
asset X at price
P
: F
-^
Profit =
P
- S P
F
-^
Gain when
P
S P
. F -^
Lose when
PS
< P
. F
v.^
If you sign a forward contract to
sell
:
-^
Profit =
P
- F P
S
3. Futures Contract
A.
Standardized forward contract[Example] “one June futures contract for Treasury bondsat a price of 115”
Topic 7, page 23
3. Futures Contract
A.
Standardized forward contract[Example] “one June futures contract for Treasury bondsat a price of 115” •One contract is for $100,000 face value of T-bonds.•Prices are quoted in points. Each point equals to $1000.
Topic 7, page 25
B.
Terminology: “Price of a futures contract” = forwardprice of the asset behind the contract signed that day.
Topic 7, page 26
[Example] Hedging Interest-rate Risk. In 06/07, the FirstNational Bank had bought $5 million of the 6s of 2023Treasury bonds at par value. Long-term bonds are exposedto substantial interest-rate risk. How to hedge the risk?i.
The Bank had taken a long position or short position?
•^
A long position
Topic 7, page 28
ECO 350 • Money and Banking
•^
A long position
[Example] Hedging Interest-rate Risk. In 06/07, the FirstNational Bank had bought $5 million of the 6s of 2023Treasury bonds at par value. Long-term bonds are exposedto substantial interest-rate risk. How to hedge the risk?i.
The Bank had taken a long position or short position?
•^
A long position
. The Bank has to
sell
the futures
Topic 7, page 29
ECO 350 • Money and Banking
•^
A long position
. The Bank has to
sell
the futures
Over the next year, interest rates increase to 8%.
Topic 7, page 31
Over the next year, interest rates increase to 8%.iii. The loss from the long position in these bonds:
Value on 06/08 @ 8% interest rate
$4,144,
Value on 06/07 @ 6% interest rate
Loss
- $ 855,
Topic 7, page 32
Over the next year, interest rates increase to 8%.iii. The loss from the long position in these bonds:
Value on 06/08 @ 8% interest rate
$4,144,
Value on 06/07 @ 6% interest rate
Loss
- $ 855,
Topic 7, page 34
ECO 350 • Money and Banking
iv. The gain from the short position on these contracts:
Amount paid to you on 06/
$5,000,
Value of bonds delivered on 06/08@8% interest rate
[Example] Hedging Foreign Exchange Risk. In January, Audi,the German car maker, is due a payment of $10 million intwo months for 10 million euro worth of cars it has just soldin USA. €1 = $1. What is the risk? Long position or shortposition?
Topic 7, page 35
[Example] Hedging Foreign Exchange Risk. In January, Audi,the German car maker, is due a payment of $10 million intwo months for 10 million euro worth of cars it has just soldin USA. €1 = $1. What is the risk? Long position or shortposition?i.
Audi is in a
long position in $
. Thus, it must
sell
dollar
Topic 7, page 37
ECO 350 • Money and Banking
i.^
Audi is in a
long position in $
. Thus, it must
sell
dollar
[Example] Hedging Foreign Exchange Risk. In January, Audi,the German car maker, is due a payment of $10 million intwo months for 10 million euro worth of cars it has just soldin USA. €1 = $1. What is the risk? Long position or shortposition?i.
Audi is in a
long position in $
. Thus, it must
sell
dollar
Topic 7, page 38
ECO 350 • Money and Banking
i.^
Audi is in a
long position in $
. Thus, it must
sell
dollar
In March, €1 = $1.20. The loss? The gain?
Topic 7, page 40
In March, €1 = $1.20. The loss? The gain?iii. The
loss
from the long position in dollars:
Topic 7, page 41
