(a) Future contract
  Agreement that require a party to the agreement either to buy or sell something at a designated future date (settlement
           or delivery date) at a predetermined price (future price)
(b) Basic Economic function
  hedge against the risk of adverse price movement (price change protection)
(c) Futures contracts
  products created by exchanges
(d) Commodity Futures Trading Commission (CFTC) --- approve contract
(e) Prior 1972, commodity futures only
(f) Financial Futures
  Stock index futures
  Interest rate futures
  currency futures
(g) Chicago Mercantile Exchange (CME) --- 2nd largest, create financial futures, currency futures (7 currencies in International
     Monetary Market (IMM)) in 1972
(h) Chicago Board of Trade (CBOT) --- established in 1848 by 82 merchants (oldest and largest future exchange in the world)
(i) CFTC (regular trade agency) --- similar to SEC, established by Congress with the headquarters in Washington D.C
(j) NFA (National Futures Association) --- The association related to futures market
 

I
Mechanics of Futures Trading
1. Liquidating a position --- settlement date : March, June, September, December (every 3 months)
  2 choices
        (a) liquidate prior to the settlement date --- take on offsetting position in the same contract (close out), no actual delivery,
             more popular
        (b) wait until the settlement date (actual delivery), only 4% or less
2. Role of clearing house
  every future exchange is associated with clearing house. For example: CBOT with BOTCC (Board of Trade Clearing
       Corporation)
       (a) Guaranteeing that the 2 parties to the transaction with perform (after initial execution of an order, take over the role of
            the other party)
       (b) make it simple to unwind positions prior to settlement date
3. Margin requirement --- Financial guarantee
  investor must deposit a minimum amount of money as specified by exchange (initial margin) --- broker firm charge higher
  small fraction of price of futures contract to enjoy the leverage
  margin : good faith money (marking to the market --- everyday update)
  maintenance margin 
  If the futures is up today, the amount of money will be deposit into the account and vice versa, check every day after
        closing
4. Market Structure
  Price is determined by open outcry of bid and offer in an auction market
  membership: seat (CBOT 3600 seats with 1402 are full membership approximately $500,000 each) (CME 2725 seats
        with 625 are full membership approximately $625,000 each)
  pit --- no specialist
  full membership --- can trade any future exchange
  Floor trader
        (a) locals : buy and sell futures for their own account (market makers)
        (b) floor broker : execute customer orders (main job) and for their own account
5. Daily price limit
  provide stability to the market
 

II
Futures vs. Forwards
 
 

Fowards	Futures
Non-standardized (term are negotiated) OTC Market between investors	Standardized (delivery date, quality, location for delivery)
No clearing house (more credit risk, no exchange, no margin)	Clearing house (Credit risk is minimal, exchanged, 95% are liquidate prior to settlement date)
OTC Instrument	Traded on Organized Exchanges
Intended for delivery	Not intended to be settle by Delivery
Single Payment at Maturity	Marked to Market (Daily Settlement)
Financial Institutions and Corporations

III
Risk and return characteristics
Long position : buy a future contract
Short position : sell a future contract
Buyer : realize profit if the future price increase
Seller : realize profit if the future price decrease

For example : today, S&P 500 buy at $1000. Mature in September 20th, actual price is $1200. Profit will be $200 X 500 = 100,000
 

IV
Pricing of Futures Contract
1. Theoretical Price
F = P + P(r-y)
where F : futures price (forward) --- complicated because market to market
          P : cash market price (current price)
          r : financing cost
          y : convenience yield (cash yield) --- yield from holding the asset
    *** (r-y) : cost of carry  (net financing cost)
 

Carry	Future Price
r > y	F > P
r < y	F < P
r = y	F = P

2. Price convergence at the delivery date
 at the delivery date the futures price must be equal to the cash market price
  law of one price ? can enjoy arbitrage
 

V
General principles of hedging with futures
major function of futures market
    -- transfer price risk from hedgers to speculators
Hedge
    -- strategy used to offset investment risk
    -- A perfect hedge is one elimination the possibility of future gain or loss (perfectly negatively correlated)
    -- locks in a value for the cash position
hedger : less risk because move risk
speculator : without speculator, the market will not exist, more aggressive because just want to make profit, depends on
     own expectation to make profit, never enjoy in delivery
1. Risk associated with hedging
    (a)  choice
  the choice of the asset underlying the future contract
  choice of the delivery month
    (b) Basis risk
  basis : spot price, future prices
  if the asset for hedge, and future construct are the same, the basis should be zero at maturity at the contract
  there is risk if the hedge maturity is different from future maturity
    (c) Cross-hedge risk
  there is risk if asset for hedge and futures contract are different
  price movement of the underlying instrument of futures contract may not accurately tract the price movement of the
              asset for hedge (example : IBM stocks vs. S&P 500)
 

VI
Role of Futures in Financial Market
provide another market (alter risk)
lower transaction cost
faster execution
substantial leverage

Long hedge and short hedge ***
1. Long hedge --- buy hedge (already have underlying asset)
     to protect against increase in the price of a financial instrument
     example : Jewelry company
2. Short hedge --- sell hedge
     to protect against decline in the future cash price of a financial instrument
     example : gold mining company