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Role of Financial Futures With Reference to Nse Nifty

Role of Financial Futures With Reference to Nse Nifty

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Published by: gauravbpit on Mar 19, 2012
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Contract specifications

An assortment of contracts. The Eurodollar contract is the linchpin of the short-
end interest rate futures contracts. Other dollar-denominate short-term interest rate
futures; no comparable contracts exist for other currencies.


Eurodollar futures

The Eurodollar futures market is the most widely traded money market contract in
the world, although trading in it only started as recently as 1981. It is based on a ninety-
day Eurodollar deposit, which is a dollar-denominate deposit with a bank or branch
outside of the U.S. or with an international banking facility (IBF) located in the U.S.
Eurodollar deposits differ from domestic term deposits or certificates of deposit in the
U.S. in that they are not regulated by U.S. authorities and hence are not subject to reserve
requirements or deposit insurance premiums. The Eurodollar futures rate on any
particular contract-month is essentially the 3-month LIBOR rate that is expected to
prevail at the maturity of the contract.

Basic contract specifications: The nominal contract size is $1 million and the
underlying rate is the three-month LIBOR, the rate at which a London bank is willing to
lend dollars (i.e., the offer side of the cash money market). The futures price is quoted as
100 minus the annualized futures 3-month LIBOR (e.g., a price of 96.5 implies a futures
LIBOR rate of 3.5% per annum) in decimal terms.

Contract settlement: Eurodollar contracts are settled in cash rather than with
physical delivery (which would entail the short opening a time deposit on behalf of the
long). The disadvantages of delivery in this case are of two kinds: (i) Eurodollar deposits
are non-negotiable and hence delivery would bind the long to a three-month investment;
(ii) heterogeneity of bank credits would systematically raise questions on the quality of
the delivered asset.

Trading of Eurodollar contracts: Eurodollar contracts are now traded at the
CME in Chicago, at LIFFE in London and at SIMEX in Singapore. Thus, Eurodollar
contract trading is de-facto available 24 hours.


Pricing and arbitrage: Implied forward rates

In order to understand how futures prices are established, we need to understand
how prices of futures contracts are related to the spot or cash market prices of the
underlying asset. We will see that the market forces of arbitrage are used to price
virtually all financial futures contracts. All examples drawn below are based on the three-
month Eurodollar contract; applications with contracts based on different currencies,
maturities or underlying asset constitute a straight-forward extension.

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