Ch05金融衍生工具8thEdition

Chapter 5
Determination of Forward and

Futures Prices
Options, Futures, and Other Derivatives, 8th Edition,

Copyright © John C. Hull 2012 1
Consumption vs Investment Assets
Investment assets are assets held by significant
numbers of people purely for investment purposes
(Examples: stocks, bonds, gold, silver)
Consumption assets are assets held primarily for
consumption (Examples: copper, oil)
we can use arbitrage arguments to determine the
forward and futures prices of an investment asset
from its spot price and other observable market
variables. We cannot do this for consumption
assets. Options, Futures, and Other Derivatives, 8th Edition,
Short Selling (Page 102-103)
Short selling involves selling securities
you do not own
Your broker borrows the securities
from another client and sells them in
the market in the usual way

Short Selling (continued)
At some stage you must buy the securities so they
can be replaced in the account of the client
You must pay to the broker any income, such as
dividends or interest, that would normally be
received on the securities that have been shorted.
The broker will transfer this income to owner of the
securities.
There may be a small fee for borrowing the
securities
Example
An investor shorts 500 shares in April when the
price per share is $120 and closes out the position
by buying them back in July when the price per
share is $100. Suppose that a dividend of $1 per
share is paid in May.
What is the net profit? assuming there is no fee for
borrowing the shares.

Example
You short 100 shares when the price is $100
and close out the short position three months
later when the price is $90
During the three months a dividend of $3 per
share is paid
What is your profit?
What would be your loss if you had bought
100 shares?
Assumptions for Valuing Futures and Forward
Contracts
Assume that the following are all true for some
market participants:
1. no transaction costs.
2. the same tax rate on all net trading profits.
3. borrow money at the same risk-free rate of interest
as they can lend money.
4. take advantage of arbitrage opportunities as they
occur.
Notation for Valuing Futures and
Forward Contracts
S0: Spot price today
F0: Futures or forward price today
T: Time until delivery date
r: Risk-free interest rate for
maturity T

Example : arbitrage opportunity?
Suppose that:
The spot price of a non-dividend-paying stock
is $40
The 3-month forward price is $43
The 3-month US$ interest rate is 5% per
annum
Is there an arbitrage opportunity?

Example : arbitrage opportunity?
An arbitrageur can borrow $40 at the risk-free interest rate
of 5% per annum, buy one share, and short a forward
contract to sell one share in 3 months. At the end of the 3
months, the arbitrageur delivers the share and receives
$43. The sum of money required to pay off the loan is
3
0.05
40e 12
 40.50
By following this strategy, the arbitrageur locks in a profit

of $43.00 - $40.50 = $2.50 at the end of the 3-month
period.
Another Arbitrage Opportunity?
Suppose that:
The spot price of nondividend-paying stock
is $40
The 3-month forward price is US$39
The 1-year US$ interest rate is 5% per
annum
Is there an arbitrage opportunity?

Another Arbitrage Opportunity?
An arbitrageur can short one share, invest the
proceeds of the short sale at 5% per annum for 3
months, and take a long position in a 3-month
forward contract.
The proceeds of the short sale grow to $40.50 in 3
months. At the end of the 3 months, the arbitrageur
pays $39 to buy one share to close out the short
position. A net gain of $40:50-$39:00= $1:50 is
therefore made at the end of the 3 months.

Condition for no arbitrage opportunities
Under what circumstances do arbitrage
opportunities such as those in Table 5.2 not exist?
The first arbitrage works when the forward price is
greater than $40.50.
The second arbitrage works when the forward price
is less than $40.50.
We deduce that for there to be no arbitrage the
forward price must be exactly $40.50.

The Forward Price
If the spot price of an investment asset is S0 and the futures
price for a contract deliverable in T years is F0, then
F0 = S0erT (5.1)
• If F0 > S0erT , arbitrageurs can buy the asset and short
forward contracts on the asset.
• If F0 < S0erT , they can short the asset and enter into long
forward contracts on it.
• In our examples, S0 =40, T=0.25, and r=0.05 so that
F0 = 40e0.05×0.25 = 40.50
16
Example 5.1
Consider a 4-month forward contract to buy a zero-coupon
bond that will mature 1 year from today.The current price of
the bond is $930. We assume that the 4-month risk-free rate
of interest is 6% per annum.
Buy using equation (5.1), the forward price is given by
F0 = 930e0.06×4/12 = 948.79

If Short Sales Are Not Possible.
To derive equation (5.1), we do not need to be able
to short the asset. All that we require is that there
be a significant number of people who hold the
asset purely for investment. If the forward price is
too low, they will find it attractive to sell the asset
and take a long position in a forward contract.
Thus Formula (5.1) still works for an investment
asset if short sales are not possible

If F0 > S0erT , an investor can adopt the following
strategy:
1. Borrow S0 dollars at an interest rate r for T years.
2. Buy 1 unit of the asset.
3. Short a forward contract on 1 unit of the asset.
At time T, the asset is sold for F0. An amount is required
to repay the loan at this time and the investor makes a
profit of F0 - S0erT .
Suppose next that F0 < S0erT. In this case, an investor who
owns the asset can:
1. Sell the asset for S0.
2. Invest the proceeds at interest rate r for time T.
3. Take a long position in a forward contract on 1 unit of the
asset.
At time T, the cash invested has grown to S0erT . The asset is
repurchased for F0 and the investor makes a profit of S0erT - F0
relative to the position the investor would have been in if the
asset had been kept.
When an Investment Asset Provides
a Known Income (page 107, equation 5.2)
F0 = (S0 – I )erT (5.2)
where I is the present value of the income during

the life of forward contract
21
Example
a long forward contract to purchase a coupon-bearing
bond whose current price is $900. We will suppose
that the forward contract matures in 9 months. We
will also suppose that a coupon payment of $40 is
expected after 4 months. We assume that the 4-
month and 9-month risk-free interest rates
(continuously compounded) are, respectively, 3% and
4% per annum.

Exercise
Consider a 10-month forward contract on a stock

when the stock price is $50. We assume that the
risk-free rate of interest (continuously compounded)
is 8% per annum for all maturities. We also assume
that dividends of $0.75 per share are expected
after 3 months, 6 months, and 9 months.
What is the forward price?

When an Investment Asset Provides
a Known Yield (Page 109, equation 5.3)
F0 = S0 e(r–q )T (5.3)
where q is the average yield during the life

of the contract (expressed with continuous
compounding)

Valuing a Forward Contract
A forward contract is worth zero (except for bid-
offer spread effects) when it is first negotiated
Later it may have a positive or negative value
Suppose that K is the delivery price and F0 is
the forward price for a contract that would be
negotiated today

Page 109-11
By considering the difference between a

contract with delivery price K and a contract
with delivery price F0 we can deduce that:
the value of a long forward contract, ƒ, is
(F0 – K )e–
rT
the value of a short forward contract is

(K – F0 )e–rT


Forward vs Futures Prices
When the maturity and asset price are the same, forward
and futures prices are usually assumed to be equal.
(Eurodollar futures are exceptions)
When interest rates are uncertain, they are, in theory,
slightly different:
A strong positive correlation between interest rates and the asset
price implies the futures price is slightly higher than the forward price
A strong negative correlation implies the reverse
Some factors may cause forward and futures prices to be different:
taxes, transactions costs, and the treatment of margins, etc.

Stock Index (Page 112-114)
Can be viewed as an investment asset
paying a dividend yield
The futures price and spot price relationship
is therefore
F0 = S0 e(r–q )T
where q is the average dividend yield on the
portfolio represented by the index during life
of contract

Stock Index (continued)
For the formula to be true it is important that
the index represent an investment asset
In other words, changes in the index must
correspond to changes in the value of a
tradable portfolio
The Nikkei index viewed as a dollar number
does not represent an investment asset (See
Business Snapshot 5.3, page 113)

Example 5.5

Index Arbitrage
When F0 > S0e(r-q)T an arbitrageur buys the
stocks underlying the index and sells futures
When F0 < S0e(r-q)T an arbitrageur buys futures
and shorts or sells the stocks underlying the
index

Index Arbitrage
(continued)
Index arbitrage involves simultaneous trades in
futures and many different stocks
Very often a computer is used to generate the
trades
Occasionally simultaneous trades are not
possible and the theoretical no-arbitrage
relationship between F0 and S0 does not hold
(see Business Snapshot 5.4 on page 114)

Futures and Forwards on Currencies
(Page 112-115)
A foreign currency is analogous to a security

providing a yield
The yield is the foreign risk-free interest rate
It follows that if rf is the foreign risk-free interest
rate
( r rf ) T
F0  S0e

Explanation of the Relationship
Between Spot and Forward (Figure 5.1)
r T
1000e f units of
foreign currency
at time T
r T
1000 F0 e f
dollars at time T

Example 5.6
Suppose that the 2-year interest rates in Australia and the
United States are 5% and 7%, respectively, and the spot
exchange rate between the Australian dollar (AUD) and the
US dollar (USD) is 0.6200 USD per AUD.
From equation (5.9), the 2-year forward exchange rate
should be
( 0.07  0.05 )2

F0  0.62e  0.6453

Futures on commodities that are investment assets
Storage costs can be treated as negative income. If U
is the present value of all the storage costs, net of
income, during the life of a forward contract, it follows
from equation (5.2) that
F0 (S0+U )erT
if u is the storage cost proportional to the price of
the commodity. Then from (5.3) we have
F0  S0 e(r+u )T

Example 5.8

Futures price of consumption assets: Storage is
Negative Income
F0  S0 e(r+u )T
where u is the storage cost per unit time as a
percent of the asset value.
Alternatively,
F0  (S0+U )erT
where U is the present value of the storage
costs.

Convenience Yields
The benefits from holding the physical asset are sometimes
referred to as the convenience yield provided by the
commodity.
If the dollar amount of storage costs is known and has a present
value U, then the convenience yield y is defined such that
F0 eyT (S0+U )erT
If the storage costs per unit are a constant proportion, u, of the
spot price, then y is defined so that
F0 eyT  S0 e(r+u )T
So F0  S0 e(r+u-y)T

Example
Table 2.2 in Chapter 2 shows that, on May
26, 2010, the futures price of soybeans
decreased as the maturity of the contract
increased from July 2010 to November 2010.
This pattern suggests that the convenience
yield, y, is greater than r + u.

The Cost of Carry (Page 118)

Futures Prices & Expected Future Spot Prices
(Page 121-123)
Suppose k is the expected return required by investors in an
asset
We can invest F0e–r T at the risk-free rate and enter into a long
futures contract to create a cash inflow of ST at maturity
This shows that
F0 e  rT e kT  E ( ST )
or
F0  E ( ST )e ( r  k )T

Futures Prices & Future Spot
Prices (continued)
No Systematic Risk k=r F0 = E(ST)

Positive Systematic Risk k>r F0 < E(ST)
Negative Systematic Risk k<r F0 > E(ST)
Positive systematic risk: stock indices

Negative systematic risk: gold (at least for some periods)


Ch05金融衍生工具8thEdition

Uploaded by

Copyright:

Available Formats

You might also like

Ch05金融衍生工具8thEdition

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Ch05金融衍生工具8thEdition

Uploaded by

Copyright:

Available Formats

Chapter 5

Determination of Forward and

Options, Futures, and Other Derivatives, 8th Edition,

Options, Futures, and Other Derivatives, 8th Edition,

Options, Futures, and Other Derivatives, 8th Edition,

Options, Futures, and Other Derivatives, 8th Edition,

Options, Futures, and Other Derivatives, 8th Edition,

By following this strategy, the arbitrageur locks in a profit

Options, Futures, and Other Derivatives, 8th Edition,

Options, Futures, and Other Derivatives, 8th Edition,

Options, Futures, and Other Derivatives, 8th Edition,

Options, Futures, and Other Derivatives, 8th Edition,

Options, Futures, and Other Derivatives, 8th Edition,

F0 = (S0 – I )erT (5.2)

where I is the present value of the income during

Options, Futures, and Other Derivatives, 8th Edition,

Consider a 10-month forward contract on a stock

Options, Futures, and Other Derivatives, 8th Edition,

where q is the average yield during the life

Options, Futures, and Other Derivatives, 8th Edition,

Options, Futures, and Other Derivatives, 8th Edition,

By considering the difference between a

the value of a short forward contract is

Options, Futures, and Other Derivatives, 8th Edition,

Options, Futures, and Other Derivatives, 8th Edition,

Options, Futures, and Other Derivatives, 8th Edition,

Options, Futures, and Other Derivatives, 8th Edition,

Options, Futures, and Other Derivatives, 8th Edition,

Options, Futures, and Other Derivatives, 8th Edition,

Options, Futures, and Other Derivatives, 8th Edition,

Options, Futures, and Other Derivatives, 8th Edition,

A foreign currency is analogous to a security

Options, Futures, and Other Derivatives, 8th Edition,

Options, Futures, and Other Derivatives, 8th Edition,

( 0.07  0.05 )2

Options, Futures, and Other Derivatives, 8th Edition,

Options, Futures, and Other Derivatives, 8th Edition,

Options, Futures, and Other Derivatives, 8th Edition,

Options, Futures, and Other Derivatives, 8th Edition,

Options, Futures, and Other Derivatives, 8th Edition,

Options, Futures, and Other Derivatives, 8th Edition,

Options, Futures, and Other Derivatives, 8th Edition,

Options, Futures, and Other Derivatives, 8th Edition,

No Systematic Risk k=r F0 = E(ST)

Positive systematic risk: stock indices

Options, Futures, and Other Derivatives, 8th Edition,

You might also like