Chapter 1&2

Financial Contracts

A forward contract is initially traded, no money changes hands.
A forward contract does have a notional value or nomi- nal value.
To protect itself against possible default, an exchange will establish a clear- inghouse.
To protect itself against possible default, an exchange will establish a clear- inghouse.

Forward Pricing

forward price = current cash price + costs of buying now – benefits of buying now
!(source/img/c1.png)

Physical commodities

  • C = commodity price2
    t = time to maturity of the forward contract
    r = interest rate
    s = annual storage costs per commodity unit
    i = annual insurance costs per commodity unit3

    F = C × (1 + r × t) + (s × t) + (i × t)

Stock

  • S = stock price
    t = time to maturity of the forward contract
    r = interest rate over the life of the forward contract
    di = each dividend payment expected prior to maturity of the forward contract
    ti = time remaining to maturity after each dividend payment
    ri = the applicable interest rate (the forward rate4) from each dividend

F=S+(S×r×t)–[d1 ×(1+r1 ×t1)]–…–[dn ×(1+rn ×tn)] = [S×(1+r×t)]–∑[dn ×(1+rn ×tn)]

Bond

B = bond price
t = time to maturity of the forward contract
r = interest rate over the life of the forward contract
ci = each coupon expected prior to maturity of the forward contract ti = time remaining to maturity after each coupon payment
ri = applicable interest rate from each coupon payment to maturity of the forward contract

F=B+(B×r×t)–[c1 ×(1+r1 ×t1)]–…–[cn ×(1+rn ×tn)] =[B×(1+r×t)]–∑[cn ×(1+rn ×tn)]

Foreign Currencies

the cost of one foreign-currency unit in terms of domestic-currency units Cd di- vided by one foreign-currency unit Cf

F = Cd/Cf × (1+rd×t) / (1+rf ×t)

Arbitrage

“a trade that results in a riskless profit.”
we will define arbitrage as the buying and selling of the same or very closely related instruments in different markets to profit from an appar- ent mispricing.
Because cash markets and futures markets are so closely related, a common type of cash-and-carry arbitrage involves buying in the cash market, selling in the futures market, and carrying the position to maturity.

Dividend

  • Declared Date. The date on which a company announces both the amount of the dividend and the date on which the dividend will be paid. Once the company declares the dividend, the dividend risk is eliminated
  • Record Date. The date on which the stock must be owned in order to re- ceive the dividend.
  • Ex-Dividend Date (Ex-Date). The first day on which a stock is trading without the rights to the dividend.
  • Payable Date. The date on which the dividend will be paid to qualifying shareholders (those owning shares on the record date).

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