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Chapter 2 Securities Markets and Transactions 15
Chapter 15
Futures Markets and Securities
Outline
Learning Goals
I. The Futures Market
A. Market Structure
1. Futures Contracts
a. Options versus Futures Contracts
2. Major Exchanges
B. Trading in the Futures Market
1. Trading Mechanics
2. Margin Trading
Concepts in Review
II. Commodities
A. Basic Characteristics
1. A Commodities Contract
2. Price Behavior
3. Return on Invested Capital
B. Trading Commodities
1. Speculating
2. Spreading
Concepts in Review
III. Financial Futures
A. The Financial Futures Market
1. Foreign Currencies, Interest Rates, and Stock Indexes
2. Contract Specification
3. Prices and Profits
B. Trading Techniques
1. Speculating in Financial Futures
a. Going Long a Foreign Currency Contract
b. Going Short an Interest Rate Contract
©2017 Pearson Education, Inc.
16 Smart/Gitman/Joehnk • Fundamentals of Investing, Thirteenth Edition
2. Trading Stock-Index Futures
a. Hedging with Stock-Index Futures
3. Hedging Other Securities
a. Hedging Foreign Currency Exposure
C. Financial Futures and the Individual Investor
D. Options on Futures
Concepts in Review
Summary
Key Terms
Discussion Questions
Problems
Case Problems
15.1 T.J.’s Fast-Track Investments: Interest-Rate Futures
15.2 Jim and Polly Pernelli Try Hedging with Stock-Index Futures
Excel@Investing
Key Concepts
1. The origins and basic operating characteristics of the futures market
2. The major organized exchanges that deal in commodities and financial futures and the role of
hedgers and speculators
3. The basic characteristics of commodity futures contracts and the main trading strategies involved
4. How prices in the futures market behave and how profits are made and lost
5. The trading techniques used with futures and a measurement of investment returns
6. The risk-return characteristics of these securities and the strategies investors employ when dealing
in commodities and financial futures
7. Commodities futures and financial futures are compared; currency futures, interest rate futures,
stock index futures, and single-stock financial futures are covered.
Overview
This chapter discusses the futures market and the various commodities and financial futures available to
investors.
©2017 Pearson Education, Inc.
Chapter 2 Securities Markets and Transactions 17
1. First, the chapter describes the futures market. Differences between the cash (spot) and futures
markets should be reviewed by the instructor. The similarities and differences between a futures
contract and a call option should also be mentioned.
2. Futures exchanges, the nature of the futures contract, and trading mechanics are also presented in
some detail. The instructor may wish to note the colorful tradition of the major exchanges, as well
as the differences between futures trading and trading on stock exchanges in terms of commissions,
deposits, delivery, pricing, etc. If the classroom is equipped for Internet access, some informative and
entertaining video clips can be found by searching YouTube for “Commodity Futures Trading Pits.”
3. The next section covers commodity trading, specific contract terms, price quotations, and return
on invested capital. Commodities futures trading is much like options trading to the extent that it, too,
can be used to speculate, hedge, or initiate spreads. The instructor may emphasize that in futures
markets, speculators operate under different rules than hedgers.
4. Individual investors are attracted to commodities markets because of the high return per dollar
invested. However, the risks are substantial, and it should be emphasized that only those investors
who are well versed in trading mechanics and pricing mechanisms—and who can tolerate large losses
—should consider these markets.
5. Financial futures are discussed in the next part of the chapter. The different interest rate, foreign
currency, stock index, and single-stock futures available to investors should be mentioned. In
addition, the characteristics and valuation concepts applicable to the different kinds of financial
futures should be stressed. Once again, the strategies of hedging, speculating, spreading, and short
selling should be repeated. It should be emphasized that, as in the commodities futures market,
returns can be high, but a high degree of investing sophistication is needed for success.
6. A discussion of futures options follows. Here, attention should center on the pricing and valuation
of these securities, as well as how they contrast with other types of puts and calls. Students are often
confused as to why investors would want to use a futures contract if futures options are available (or
vice versa), so some time could be spent discussing/illustrating the comparative advantages and
disadvantages of futures versus futures options.
7. Much effort went into updating the illustrations; however, the institutional details of future
markets evolve rapidly, so the instructor is urged to review the financial press and verify that no
subsequent changes have been made.
Answers to Concepts in Review
©2017 Pearson Education, Inc.
18 Smart/Gitman/Joehnk • Fundamentals of Investing, Thirteenth Edition
1. A futures contract is a firm commitment (i.e., an obligation) to deliver or receive a certain amount
of a specified item at some specified date in the future. The seller of the contract agrees to make the
specified future delivery, and the buyer agrees to accept and pay for it at the specified future date.
2. Whenever a commodity changes hands in exchange for a cash price paid to the seller, we say that
3. The only source of return from commodity futures is capital gains. Futures do not have any kind
4. The futures market contains two types of traders: hedgers and speculators. Hedgers are the
producers, processors, and financial managers who use futures to protect their interest in the
5. All commodity and futures contracts are traded on a margin basis. An investor can acquire a
futures contract by depositing a small portion of the total cost of the contract with a broker; this
a. The initial deposit specifies the amount of investor capital that must be deposited with the broker
b. Yes, if the market moves against the investor and the value of the contract drops by more than the
6. The five essential elements of a commodities contract are as follows:
©2017 Pearson Education, Inc.
Chapter 2 Securities Markets and Transactions 19
The size of the contract, the price of the underlying commodity, and the pricing unit have the most
7. a. Settlement price: the last price of the day, or the closing price
8. The only source of return for a futures contract is capital gains. Investors realize capital gains
The return on commodity futures is calculated using the return on invested capital. This measure is
Selling price Purchase price
of contract of contract
Return on invested capital Amount of margin deposit
-
=
©2017 Pearson Education, Inc.
20 Smart/Gitman/Joehnk • Fundamentals of Investing, Thirteenth Edition
9. One may invest in commodities by: (1) hedging, (2) spreading, or (3) speculating. Hedging is used
by producers and processors to protect a position in a product or commodity. It is a “technical”
10. Financial futures are simply an extension of the commodities concept and as such, financial and
The price behavior of a commodities contract depends on the price behavior of the commodity
itself, just as the price behavior of interest rate and stock index futures depends on movement in
11.Both currency and interest rate futures are forms of financial futures—futures contracts written on
large amounts of underlying financial assets. Currency contracts are written on foreign currencies,
like the British pound, Japanese yen, or the euro, and they derive their values from the strength or
Stock index futures are futures contracts written on popular stock market indexes (like the S&P
500 or the Nasdaq 100 Index). They enable investors to “buy the market” as a whole and speculate on
12. Stock index futures can be used for speculative purposes when the market goes either up
or down. Because these futures enable speculators to “play the market as a whole,” the key to success
is to correctly predict the future course of the stock market: If the market as a whole (as measured by,
©2017 Pearson Education, Inc.
Chapter 2 Securities Markets and Transactions 21
The biggest advantage to speculating with stock index futures is that the investor need only
specify the future direction of the market as a whole, rather than select the specific/individual issues
Stock index futures are normally used for hedging as a way to protect a portfolio of common
13. Futures options are listed puts and calls that are written on standardized commodities
futures
(e.g., corn and gold) and financial futures (e.g., Treasury bond futures and stock index futures).
They represent put and call options on large amounts of the underlying futures contracts: $100,000
©2017 Pearson Education, Inc.
