Financial Futures

Although futures have their origins in commodities, financial futures, viz., equity futures, interest rate futures, and currency futures dominate the market today.

Equity Futures:

Equity futures etc of two types: stock index futures and individual stock futures.

Stock index futures are futures on stock market indices such as the Standard & Poor’s 500 in the US or Nifty in India. Because it is very inconvenient to deliver the index, stock index futures contracts are settled by a cash amount which is equal to the difference between the contracted futures price and the final index value times a multiplier that scales the contract size.

Individual stock futures are futures on individual stocks. The list of stocks on which futures contracts are permitted may be specified by the exchange or the regulatory body. Individual stock futures may be settled by delivery or a cash amount.

Interest rate futures:

A future on an asset whose price depends solely on the level of interest rates is called an interest rate futures contract.

There are interest rate futures contracts on assets like Eurodollars, Treasury bills, Treasury notes, and treasury bonds.

For example the Treasury bond futures traded on the Chicago Board of Trade (CBOT) require the delivery of any Treasury bond which has maturity of more than 15 years and which is not cancelable for at least the first 15 years. Since bonds of different maturities and coupons have different prices, the CBOT applies a conversion factor to adjust for these differences.

The conversion factor is based on the value of the bond on the first day of the delivery month on the assumption that the interest rate for all maturities is equal to 8 percent per annum (with semiannual coupon).To illustrate this procedure let us consider a 10 percent coupon bond with a maturity of 18 years. Working with a standard of $100 face value, the value of the bond can be calculated, using a discount rate of 8 percent.

The seller of a futures contract can deliver any one of a menu of Treasury bonds to fulfill the obligation. Naturally, the seller will deliver the cheapest bond on the menu, after adjusting for conversion factor. Hence this delivery option is priced into the futures contract.

Foreign Exchange Futures:

Exchange rates between currencies fluctuate over time and often considerably. This variability bothers anyone engaged in international operations. To cope with the exchange rate risk, forward and futures contracts may be employed.

The forward market in foreign exchange is a somewhat informal network of banks and brokers that enables customers to enter into forward contracts to buy or sell currency in future at a price fixed today. Forward contracts in currencies are customized. There is no marking to market and execution takes place only at the maturity date.

Futures contacts in currencies take place in formal markets such as the Chicago Mercantile Exchange (International Monetary Market) and the London International Financial Futures Exchanges. On such markets, contracts are standardized by size and marking to market is done on a daily basis. Further standard clearing arrangements allow traders to reverse positions.

1. Futures contacts on debt instruments:
US Treasury bond futures contact. This is a contract for delivery of US Treasury bonds with $100,000 face value and having a maturity of atleast 15 years from the delivery date.

2. Futures contact on monetary metals:
Futures contract on gold: This is a contract or delivery of 100 troy ounces of gold of 0.995 fineness.

3. Futures contract on foreign currencies:
Futures contact on British pound. This is a contact for delivery of 25,000 British pounds, on the appropriate future date.

4. Futures contraction stock markets indices:
Futures contract on S&P 500: The underlying value of the contract is $500 times the S&P 500 index. Unlike other futures contracts, the settlement of an index futures contract is by cash payment.