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Pricing Of Financial Futures And Commodity For Security Analysis And Portfolio Management MCOM Sem 3 Delhi University Notes

Pricing Of Financial Futures And Commodity For Security Analysis And Portfolio Management MCOM Sem 3 Delhi University :  Here we provide direct download links for Pricing Of Financial Futures And Commodity For Security Analysis And Portfolio Management MCOM Sem 3 Delhi University Notes in pdf format. Download thesePricing Of Financial Futures And Commodity For Security Analysis And Portfolio Management MCOM Sem 3 Delhi University Complete notes in pdf format and read well.

Pricing Of Financial Futures And Commodity For Security Analysis And Portfolio Management MCOM Sem 3 Delhi University Notes

Pricing Of Financial Futures And Commodity For Security Analysis And Portfolio Management MCOM Sem 3 Delhi University :  A commodity futures contract is an agreement to buy or sell a predetermined amount of a commodity at a specific price on a specific date in the future. Buyers use such contracts to avoid the risks associated with the price fluctuations of a futures’ underlying product or raw material. Sellers use futures contracts to lock in guaranteed prices for their products.

Download here Pricing Of Financial Futures And Commodity For Security Analysis & Portfolio Management MCOM Sem 3 Delhi University Notes in pdf format 

BREAKING DOWN ‘Commodity Futures Contract’

Besides hedgers, which are all financial markets, speculators can use commodities futures contracts to make directional price bets on raw materials. Trading in commodity futures contracts can be very risky for the inexperienced. One cause of this risk is the high amount of leverage involved in holding futures contracts. For example, for an initial margin of about $3,700, an investor can enter into a futures contract for 1,000 barrels of oil valued at $45,000 (with oil priced at $45 per barrel). Given this large amount of leverage, a very small move in the price of a commodity could result in large gains or losses compared to the initial margin. Unlike options, futures are the obligation of the purchase or sale of the underlying asset. Simply not closing an existing position could result in an inexperienced investor taking delivery of a large quantity of an unwanted commodity. Speculation using short positions in futures can lead to unlimited losses.

Commodity Futures Hedging Example

Buyers and sellers can use commodity futures contracts to lock in the purchase of sale prices weeks, months or years in advance. For example, assume that a farmer is expecting to produce 1,000,000 bushels of soybeans in the next 12 months. Typically, soybean futures contracts include the quantity of 5,000 bushels. If the farmer’s break-even point on a bushel of soybeans is $10 per bushel and he sees that one-year futures contracts for soybeans are currently priced at $15 per bushel, it might be wise for him to lock in the $15 sales price per bushel by selling enough one-year soybean contracts to cover his harvest. In this example, that is (1,000,000 / 5,000 = 200 contracts).

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One year later, regardless of price, the farmer delivers the 1,000,000 bushels and receives $15 x 200 x 5000, or $15,000,000. This price is locked in. But unless soybeans are priced at $15 per bushel in the spot market that day, the farmer has either received less than he could have or more. If soybean were priced at $13 per bushel, the farmer receives a $2 per bushel benefit from hedging, or $2,000,000. Likewise, if the beans were priced at $17 per bushels, the farmer misses out on an additional $2 per bushel profit.

Pricing Of Financial Futures And Commodity For Security Analysis And Portfolio Management MCOM Sem 3 Delhi University Notes

Pricing Of Financial Futures And Commodity For Security Analysis And Portfolio Management MCOM Sem 3 Delhi University :  In the futures market, margin has a definition distinct from its definition in the stock market, where margin is the use of borrowed money to purchase securities. In the futures market, margin refers to the initial deposit of “good faith” made into an account in order to enter into a futures contract. This margin is referred to as good faith because it is this money that is used to debit any day-to-day losses.

When you open a futures contract, the futures exchange will state a minimum amount of money that you must deposit into your account. This original deposit of money is called the initial margin. When your contract is liquidated, you will be refunded the initial margin plus or minus any gains or losses that occur over the span of the futures contract. In other words, the amount in your margin account changes daily as the market fluctuates in relation to your futures contract. The minimum-level margin is determined by the futures exchange and is usually 5% to 10% of the futures contract. These predetermined initial margin amounts are continuously under review: at times of high market volatility, initial margin requirements can be raised.

The initial margin is the minimum amount required to enter into a new futures contract, but the maintenance margin is the lowest amount an account can reach before needing to be replenished. For example, if your margin account drops to a certain level because of a series of daily losses, brokers are required to make a margin call and request that you make an additional deposit into your account to bring the margin back up to the initial amount.

Let’s say that you had to deposit an initial margin of $1,000 on a contract and the maintenance margin level is $500. A series of losses dropped the value of your account to $400. This would then prompt the broker to make a margin call to you, requesting a deposit of at least an additional $600 to bring the account back up to the initial margin level of $1,000.

Word to the wise: when a margin call is made, the funds usually have to be delivered immediately. If they are not, the brokerage can have the right to liquidate your position completely in order to make up for any losses it may have incurred on your behalf.

Leverage: The Double-Edged Sword

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In the futures market, leverage refers to having control over large cash amounts of commodities with comparatively small levels of capital. In other words, with a relatively small amount of cash, you can enter into a futures contract that is worth much more than you initially have to pay (deposit into your margin account). It is said that in the futures market, more than any other form of investment, price changes are highly leveraged, meaning a small change in a futures price can translate into a huge gain or loss.

Futures positions are highly leveraged because the initial margins that are set by the exchanges are relatively small compared to the cash value of the contracts in question (which is part of the reason why the futures market is useful but also very risky). The smaller the margin in relation to the cash value of the futures contract, the higher the leverage. So for an initial margin of $5,000, you may be able to enter into a long position in a futures contract for 30,000 pounds of coffee valued at $50,000, which would be considered highly leveraged investments.

You already know that the futures market can be extremely risky and,therefore, not for the faint of heart. This should become more obvious once you understand the arithmetic of leverage. Highly leveraged investments can produce two results: great profits or greater losses.

As a result of leverage, if the price of the futures contract moves up even slightly, the profit gain will be large in comparison to the initial margin. However, if the price just inches downwards, that same high leverage will yield huge losses in comparison to the initial margin deposit. For example, say that in anticipation of a rise in stock prices across the board, you buy a futures contract with a margin deposit of $10,000, for an index currently standing at 1300. The value of the contract is worth $250 times the index (e.g. $250 x 1300 = $325,000), meaning that for every point gain or loss, $250 will be gained or lost.

If after a couple of months, the index realized a gain of 5%, this would mean the index gained 65 points to stand at 1365. In terms of money, this would mean that you as an investor earned a profit of $16,250 (65 points x $250); a profit of 162%!

On the other hand, if the index declined 5%, it would result in a monetary loss of $16,250 – a huge amount compared to the initial margin deposit made to obtain the contract. This means you still have to pay $6,250 out of your pocket to cover your losses. The fact that a small change of 5% to the index could result in such a large profit or loss to the investor (sometimes even more than the initial investment made) is the risky arithmetic of leverage. Consequently, while the value of a commodity or a financial instrument may not exhibit very much price volatility, the same percentage gains and losses are much more dramatic in futures contracts due to low margins and high leverage.

Pricing Of Financial Futures And Commodity For Security Analysis And Portfolio Management Mcom Sem 3 Delhi University Notes

Pricing Of Financial Futures And Commodity For Security Analysis And Portfolio Management MCOM Sem 3 Delhi University :   The basic difference between commodity and financial Futures is the nature of the underlying instrument. In a commodity Futures, the underlying is a commodity which may be Wheat, Cotton, Pepper, Turmeric, corn, oats, soybeans, orange juice, crude oil, natural gas, gold, silver, pork-bellies etc. In a financial instrument, the underlying can be Treasuries, Bonds, Stocks, Stock-Index, Foreign Exchange, Euro-dollar deposits etc. As is evident, a financial Future is fairly standard and there are no quality issues while a commodity instrument, quality of the underlying matters.

Pricing Of Financial Futures And Commodity For Security Analysis And Portfolio Management Mcom Sem 3 Delhi University Notes

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