CFA Level 1
Derivatives - Other Types of Derivatives
Eurodollar futures work the same as T-bill contracts except the rate is based on LIBOR.
- Price quotes and actual price is determined the in the same way as for T-bills.
- Settles in cash
- One of most active contracts in the markets
- Instead of add-on interest, (for example a 100 @ 10% for a year and the bank would owe $110 dollars), the rate is subtracted from 100, just as it is with T-bills
- With T-bills the investor would receive $1 million per contract, while in the Eurodollar futures market the firm would pay 1 million euros
Treasury Bond Contracts
A contract based on the delivery of a U.S. Treasury bond with any coupon and at least 15 years to maturity.
- There are many different bonds that fit the above description.
- To give some type of standardization, the markets use a conversion factor to achieve a hypothetical bond with a 6% coupon.
- Because bond prices do not move in a linear fashion, there is a chance to use arbitrage to capitalize on the deviance of a bond when compared to the 6% standardized bond. To do this, traders look for the cheapest to deliver bond (CTD). This is the least expensive underlying product that can be delivered upon expiry to satisfy the requirements of a derivative contract. This helps minimize the slippage between the conversation factor and the actual price.
- The CTD bond is always changing because prices and yields are always changing.
- A contract covers $100,000 par value of U.S. Treasuries.
- Contract expires March, June, September and December
Stock Index Contracts
Investors trading index options are essentially betting on the overall movement of the stock market as represented by a basket of stocks. Options on the S&P 500 are some of the most actively traded options in the world.
- Quoted in terms equal to the index itself. For example if the S&P 500 is trading at 1050 the one-month contract may be at 1060.
- Each contract has a multiplier. For the S&P 500, it is 250. The actual price in the above point would equal 1060 x 250 = $265,000.
- S&P 500 contracts expire in March, June, September and December and can have maturity dates as far away as two years.
- Settlement is in cash.
- The FTSE 100 and Japan's Nikkei 225 are other types of indexes upon which stock index contracts are based.
Currency contracts function in the same way as forward contracts for currency.
- They are typically much smaller than forward contracts.
- Each contract has a stated size and quotation unit.
- Future price for euros = 0.92, which leads to a contract price of 125,000(this is the contract size)(.92) = 115,000
- Calls for actual delivery through book entry of the underlying currency.
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