Intermediate: Futures & Forwards

Intermediate Futures & Forwards
Corporate Finance Institute®

Futures & Forward Contracts

Types of Derivative Contracts
Common derivative contracts include forwards, futures, options, and swaps.
Forward Commitment Contingent Claims
Forwards Futures Swaps Options
This Course

What Is a Forward Contract
A forward contract is an agreement between two parties to exchange an asset for a pre-specified price
on a specific date in the future.
Example 1
In one year’s time, Party A agrees to purchase 8,000 barrels of oil from Party B at $50 per barrel.
8,000 barrels of oil
$40,000 USD
Party A Party B
Example 2
In one month’s time, Party A agrees to purchase $500,000 USD from Party B for $675,000 CAD.
Example 3
In five year’s time, Party A agrees to purchase 600 troy ounces of gold from Party B for $900,000 USD.

What Is the Purpose of a Forward Contract
Forwards are over-the-counter contracts. Although they can be used for speculating, the
customizability makes forwards very useful for hedging.
For example, industries that heavily rely on commodities, such as an airline on jet fuel, can hedge the
price of fuel using forwards to reduce volatile prices.
Hedging VS Speculating

What Is a Futures Contract
A futures contract is similar to a forward contract. It is an agreement to exchange an underlying

asset for a pre-specified price at a specified date in the future.
The major differences include:
01 Futures contracts are traded on exchanges rather than over-the-counter
02 Futures contracts have standardized contract terms
03 Futures contracts involve margins

What Is the Purpose of a Futures Contract
Futures contracts are often used for hedging; however, the liquidity of futures contracts and the ability
to leverage through margins makes futures attractive for speculating.
Liquidity Leverage through margins

Futures Contract Specifications
A futures contract is an agreement to exchange a commodity for a pre-specified price at a specified

date in the future.
Today Delivery Date
• Contract size: the defined volume • Physical delivery: commodity delivered in

exchange for cash
• Tick value: the minimum price fluctuation per
contract OR
• Ticker: an individual code that exchanges • Cash settlement: gains and losses exchanged
assign to the commodity future in cash entirely
• Initial margin: the amount of money that
needs to be deposited as a guarantee
• Price: the agreed contract price

Mechanics of the Exchange – Margins
A major difference between forwards and futures is that futures contracts are settled daily.
A counterparty’s margin account is credited or debited as the spot price of the underlying asset changes.
Counterparty A Margin Call Counterparty B
If the margin account of the buyer or seller falls below a certain point, known as the minimum required
margin or secondary margin, a margin call will happen.
The counterparty is required to deposit more money into the margin account to retain their position.

Futures Contract – Worked Example
We are going to calculate the margin requirements

for the following contract:
Oil Futures Contract

Delivery Date 3 days from now
Futures Price $50.00 USD per barrel
Contract Size 1,000 barrels
Tick $0.01
Tick Value $10 ($0.01 tick x 1,000 barrels)
Settlement Physical Delivery
Initial Margin $5,000 The amount needed to deposit
Maintenance Margin $3,000 Minimum balance required
Number of Contracts 10 10,000 barrels (10 contracts x
1,000 barrels)

Futures Contract – Worked Example
Exposure: $50/bbl x 1,000 bbls x 10 contracts = $500,000 Tick: $0.01 per barrel
Initial Margin: $5,000 x 10 contracts = $50,000 Tick Value: 1,000 x $0.01 x 10 contracts = $100
Maintenance Margin: $3,000 x 10 contracts = $30,000
Day 1 Day 2 Day 3 (Expiration)

Settlement Price $51.10/barrel $47.50/barrel $50.20/barrel
Beginning Margin Account $50,000 $61,000 $50,000
Tick Movement 110 -360 270
Change to Margin Account +$11,000 -$36,000 +$27,000
Total Before Margin Call $61,000 $25,000 $77,000
Margin Call $0 $25,000 Margin Call 0
Ending Margin Account $61,000 $50,000 $77,000
Deposited Amount $50,000 $75,000 $75,000
Net Gain(Loss) $11,000 -$25,000 $2,000

Pricing Futures Contracts

How Are Futures Prices Calculated
Imagine that you plan to buy 1,000 barrels of oil in 1 year’s time. There are two strategies you can
consider:
Strategy 1: Buy Now and Hold Strategy 2: Buy a Futures Contract
Borrow money to buy the 1,000 barrels of oil Buy the futures contract for 1,000 barrels of
at the spot price and hold it for one year. oil with an expiration in one year’s time.
At the one-year mark you would pay back the The cost in this scenario would simply be the
amount and any interest. cost of the futures contract.

Let’s assume the spot price is $50/barrel, the cost of borrowing is 5%, and the cost of storing 1,000
barrels of oil is $2,000.
Let’s also assume a 1-year futures contract is priced at $55/barrel (or $55,000 per contract).
Strategy 1: Buy Now and Hold Strategy 2: Buy a Futures Contract
Cost = Spot Price + Carry Cost (Interest + Cost = Futures Contract Price
Storage)
Cost = $50 x 1,000 + ($50 x 1,000) x 5% + $2,000 Cost = $55,000
Cost = $54,500
If this were the case, what could an investor do to profit from this situation?

If the spot price and futures price are not in equilibrium, there is an arbitrage opportunity:
Action Cash Position

Strategy 1: Buy and Hold
Borrow $50,000 +50,000
Cost = $54,500 Buy 1,000 barrels of oil at the spot price -50,000
Pay interest and storage costs -4,500
Sell a futures contract for 1,000 barrels +55,000
Repay the loan -50,000
Total: +$500
Strategy 2: Sell a Futures Contract
Cost = $55,000

The Futures Price Formula
Futures Price = Spot Price + Carry Costs – Carry Return
Note: small arbitrage opportunities may not be exploited because of transaction costs in practice.
Carry Costs Carry Returns

Interest Coupons
Transport and Warehousing Dividends
Insurance Convenience (consumable assets)
• Premium to hold the underlying commodity

instead of the futures contract
• Driven by scarcity and high demand
The difference between the futures price and spot price is not the expected price appreciation or
depreciation of the underlying asset.

Contango and Backwardation Markets
Price

Contango Market
Spot Price
Backwardation Market
Settlement
Contango Market: Carry Cost > Carry Return

Backwardation Market: Carry Cost < Carry Return

Commodity Futures – Crude WTI Overview
Commodity futures are typically

contango (since carry costs >
carry returns)

Commodity Futures – Crude WTI Contracts
Increasing Price

Equity Index Futures – FTSE 100
Equity index futures are typically

a backwardation market (since
carry costs < carry returns)

Equity Index Futures – FTSE 100 Contracts
Decreasing Price

Pricing Futures Example
An investor living in Seattle, Washington, wishes to purchase 100 troy oz of gold in June from Wisconsin.
The storage fees are 2%, the cost of insurance is 3%, and the cost of transportation is $5 per troy oz.
The investor borrows $170,000 and incurs a total interest expense of $500. The current price of gold is
$1,600/troy oz, and the futures contract is trading at $1,697/troy oz.
How much will it cost this investor to purchase 100 troy oz of gold?

Pricing Futures Example – Strategy One
Strategy One (Cash and Carry)
Expenses Cash Position

Buy 100 troy oz of gold (100 x $1,600) -$160,000
Storage fees (2% x $160,000) -$3,200
Cost of insurance (3% x $160,000) -$4,800
Carry Costs
Cost of transportation ($5 x 100) -$500
Interest expense -$500
Total cost: -$169,000
Price/Oz: $169,000/100 = $1,690

Pricing Futures Example – Strategy Two
Strategy Two (Buy a Future)
• Buy a futures contract

• Pay $169,700 in June ($1,697 x 100)
• Take delivery
Cost = Futures Contract Price

Pricing Futures Example – Arbitrage
Arbitrage Strategy Cost

Cash Position
Borrow $170,000 +$170,000
Strategy One
Buy gold on the spot market -$169,000 $160,000
(Cash and
+ $9,000
Sell gold on the futures contract +$169,700 Carry)
Repay loan -$170,000
Profit: $700
Strategy Two
(Futures $169,700
Contract)
What will happen to the spot price and futures contract prices of gold?

Commodity Futures Contracts

Major Commodity Futures Categories
Grains and Oilseeds Softs Livestock
• Corn, wheat, oats • Lumber, cotton, sugar, • Farm animals

coffee, orange juice, (pigs, cows)
cocoa
Energy Base/Industrial Precious Metals

Metals
• Crude oil (and distillates), • Steel, copper, nickel, tin • Gold, silver, platinum,
natural gas, electricity palladium

Futures Contract – Bloomberg Example

Futures Contract – Ticker
Commodity: Gold
Gold Ticker

Commodity: Gold
GC: Exchange Symbol

Commodity: Gold
J: Delivery Month

Commodity: Gold
J: Delivery Month
Delivery Months & Codes

Commodity: Gold
0: Year

Futures Contract – Contract Size
Contract Size
1,000 Troy Ounces = 10 GC Contracts

Futures Contract – Tick Size and Value
Tick Size and Value
$0.1 x 100 Troy Oz. = $10

Futures Contract – Price and Contract Value
Price &
Contract Value

Futures Contract – First and Last Trade
First and Last Trade

Futures Contract – First Notice
CME Comex gold futures require physical delivery.
First Notice Date: the futures contract buyer may be required to

take physical delivery of the commodity on the first notice date.
If not, the trader needs to close out their position before the
first notice day.
First Notice

Futures Contract – Delivery Month
Delivery Month

Futures Contract – Available Contracts

Futures Contract – Available Contracts
Futures Schedule
Use the scrollbar to view

more delivery dates

Futures Contract – Volume and Liquidity
The highest liquidity is always in

the shorter maturities with the
most market depth and size.
Liquidity in commodity futures

almost always decreases as you
go out further in maturity.
Volume
Futures traders will receive the

Highest Volume best execution fills where there
is the greatest liquidity.
Volume declines as the delivery

date gets close.

Futures Contract – Bid/Ask Spreads
Bid/Ask Spread
0.30
Futures traders will receive the
0.10 best execution fills where there
0.20
0.20 is the greatest liquidity.
0.20
0.40
0.30
0.40
1.30
2.10
13.50

Futures Contract – Open Interest
Open interest numbers are the

number of futures contracts that
have not yet been canceled by an
offsetting trade.
Open Interest
A contract with low volume but

a large open interest:
There are participants who are
willing to trade.

Futures Contract – Open Interest
Open interest numbers are the

number of futures contracts that
have not yet been canceled by an
offsetting trade.
Open Interest
A contract with low volume but

a large open interest:
There are participants who are
willing to trade.

Currency Forward Contracts

Currency Forward Contracts Overview
Market Share by FX Products

Options
Currency Swaps 5%
2%
Spot
30%
FX Swaps
29%
Forwards
15%

What Is an Exchange Rate
An exchange rate is the price of one currency in terms of another, also known as an FX pair.
FX that trades for T+2 (trade date plus two) settlement is called “spot”.
Example:
A trade of $1 million USD/JPY at 110.15 means that in two days’ time:
The buyer of JPY will remit The seller of JPY will remit
$1,000,000 USD. ¥110,150,000.

How Are Currencies Identified
Currency codes fall under ISO code 4217. They are three letters long and comprised of:
US D
GBP CAD THB
Country Currency
However, the convention is not consistent anymore. A few confusing ones:
IDR vs. INR Nicknames – Swissy,

(Indonesian Rupiah EUR – Euro BRL – Brazilian Real Loonie, Kiwi, Aussie,
vs. Indian Rupee) Cable, Chunnel

FX Pairs
Base Quote
Currency Currency
USD / SEK
USD / JPY
Base Quote
Currency Currency

FX Pairs
Historically, we used the stronger currency as the base currency, but there are exceptions.
Higher Priority
Euro
Pound Sterling
Australian Dollar
New Zealand Dollar

Correct Quote Incorrect Quote
United States Dollar
Canadian Dollar EUR / USD USD / EUR

Swiss Franc EUR / JPY JPY / EUR
Japanese Yen
Lower Priority

How Are FX Rates Quoted
Why is…
VS
USD/JPY = 110.15 USD/CAD = 1.3067
2 Decimals 4 Decimals
Market convention is to quote to 5 significant figures (”sig figs”).
Remember that the “0.” is also considered a sig fig so NZDUSD is 0.6593.

Bid/Ask Spreads
The market quotes prices using the last two digits in a price.
EUR/USD = 1.1009-14
Bid/ask spread of
5 pips (points)
Big Figures (Big Figs) Pip (Point)
Largely ignored as Last digit in the price

market-makers assume
it is understood

FX Forwards
FX forwards are agreements made today to deliver currency at some point

in the future, hence the word “forward”.
They are over-the-counter contracts with no payment or physical exchange
of funds upfront.
Trades are negotiated on No principal is exchanged FX forwards are more suited

“trade date” and settle on until the future date, known to hedging a one-time
“spot value date” (generally also as the ”delivery date”, payment rather than a
two business days from the or “forward value date”. stream of principal plus
trade date). interest payments.

FX Forwards – ON
ON: Overnight

FX Forwards – TN
TN: Tomorrow Next

FX Forwards – SP
SP: Spot

FX Forwards – SN
SN: Spot Next

FX Forwards – 1W, 1M, 1Y
EUR/USD SP: 1.1273

1.1273 + 0.000171 = 1.127471
1W: 1 Week
1M: 1 Month
1 Euro in the future buys more US Dollars
1Y: 1 Year

FX Forwards Example
A U.S. construction company, Buildco, signed a JPY 500 million contract to buy elevators from Liftco, a
Japanese company.
The contract will be paid in a year’s time. The USD/JPY spot rate is 110.00.
iUSD = 1.50%
USD $4.55MM $4.62MM
USD/JPY Spot USD/JPY Forward

= 110.00 =?
JPY ¥499.50MM ¥500.00MM

iJPY = 0.10%
Now t = One Year

Calculating Forward Prices
Forward price is the relationship between exchange rates and interest rates.
Forward Exchange Rate = Spot Rate + Interest Rate Differential
1 + i𝒒 ⋅ t
F=S
1 + i𝒃 ⋅ t
Where:
F = Forward rate
S = Spot rate
i𝒒 = Simple interest rate of the quote currency
i𝐛 = Simple interest rate of the base currency
t = Tenor in years (calculated according to the appropriate day count convention)

Calculating Forward Prices Example
iUSD = 1.50%
USD $4.54MM $4.61MM
1 + 0.001⋅ 1
USD/JPY Spot USD/JPY Forward F = 110.00
= 110.00 =?
1 + 0.015⋅ 1
= 108.48
JPY ¥499.50MM ¥500.00MM

iJPY = 0.10%
Now t = One Year

Quoting Forward Rates
Forward differentials, or forward points, is the difference between the spot rate and the forward rate.
Spot FX rate = 110.00

Forward points = 1.52
Forward FX rate = 108.48
How to quote forward rates?
If forward points are quoted If forward points are quoted

high-low, subtract the points low-high, add the points to the
from the spot rate. spot rate.

Quoting Forward Rates Example
GBP/USD Spot Forward Points

1.3022-1.3026 11-12
Correct Quote Incorrect Quote
Spot 1.3022-1.3026 Spot 1.3022-1.3026

+ + – –
Forward Point 0.0011 0.0012 Forward Point 0.0011 0.0012
=
=
=
=
Forward Rates 1.3033-1.3038 Forward Rates 1.3011-1.3014
5 points 3 points

Another FX Forward Example
A client needs to sell forward USD $100 million for British pound sterling on January 3, 2021.
Dates Day Count
Transaction Date April 1, 2020 N/A Rates
Spot Value Date April 3, 2020 N/A GBP/USD Spot 1.2077-1.2079
Forward Value Date January 3, 2021 275 6-Month Forward Points 32.5-34.5
6 Months Forward October 2, 2020 182 12-Month Forward Points 37.5-40.5
12 Months Forward April 3, 2021 365

Another FX Forward Example
A client needs to sell forward USD $100 million for British pound sterling on January 3, 2021.
0.00405 – 0.00345 0.00060 0.000003

= =
365 days – 182 days 183 points/day
Buy (Bid) Sell (Ask)

1.2077 1.2079 0.000003 x (275 – 182 days) = 0.000279
32.5 34.5
37.5 40.5
GBP/USD Spot 1.2079
6-Month Forward Points 0.00345
Additional 93 Days Points + 0.000279
Forward Rate 1.211629

FX Forwards Exercise
Prove that you can add or

subtract the “Fwds Bid”
points to get the forward
rates for:
• 3-month
• 6-month
• 1-year
The answers will be

provided as an Excel file
following this exercise.

Equity Index Futures Contracts

Equity Index Futures Overview
Equity index futures allow investors to buy or sell an index today that will be settled at a future date.
Speculation Hedging
Using equity index futures to Losses on equity positions can be

predict an upward or downward mitigated by portfolio managers
price movement for an index. and investors through using equity
index futures.

Common Stock Indexes
Equity index futures are based on various stock market indexes.
Example: Dow Jones Industrial Average (DJIA). DJIA represents a portfolio of 30 large corporate
companies such as:
• Apple (NASDAQ: AAPL)
• Coca-Cola Co. (NYSE: KO)
• Boeing Co. (NYSE: BA)
• Microsoft Corporation (NASDAQ: MSFT)
• Intel Corporation (NASDAQ: INTC)
Can you name any other indexes?

Major Stock Indexes – Bloomberg



Selection of Equity Index Futures

Selection of Equity Index Futures

Index Futures Contract Sizes
For example, the CME S&P 500 contract comes in three sizes:
CME
Three Contract
Sizes Available
Micro E-mini
S&P 500 E-mini S&P 500
S&P 500
Contract multiplier: Contract multiplier: Contract multiplier:

$250 $50 $5

Micro E-Mini S&P 500 Futures Contract – Ticker
U: September
0: 2020

Micro E-Mini S&P 500 Futures Contract – Contract Size & Value

Micro E-Mini S&P 500 Futures Contract – Margin Requirements

E-Mini S&P 500 Futures Contract – Ticker

E-Mini S&P 500 Futures Contract – Contract Size & Value

E-Mini S&P 500 Futures Contract – Margin Requirements

E-Mini S&P 500 Futures Contracts
Quarterly

How Index Futures Settle
Index futures contract cash settle as you cannot

physically deliver the index.
The cash settlement is calculated comparing the

equity index on expiration with the index “price” in the
contract.
If the price of the index on expiry > the contract price:

• The index futures buyer (who is said to be long the
index) has made a profit.
• The index futures seller (who is said to be short the
index) incurs a loss.

Using Equity Index Futures to Speculate or Hedge
Speculating
OR Hedging
• Anticipate rise: buy (long). • Commonly used by equity

• Anticipate fall: sell (short). buy-side portfolio managers.
• Leverage with an initial margin. • Anticipate decline in equity

portfolio: short equity index
futures to hedge some risk.

Equity Index Future Speculation Example
A trader enters into a E-mini CME S&P 500 futures contract

at a level of 3,000 expecting the S&P 500 to increase.
If the futures contract increases by 125 index points or

by 500 ticks, what would the contract value be worth and
what profit would the trader make?

Equity Index Future Speculation Answer
A trader enters into a E-mini CME S&P futures contract at a

level of 3,000.
3,000 x $50 multiplier = $150,000

500 ticks x $12.50 tick value = $6,250
Total Contract Value = $156,250
Profit = $6,250
Alternate Calculation:
Since 4 ticks equals 1 index point;
500 ticks ÷ 4 ticks/index point = 125 index points
125 index points x $50 multiplier = $6,250

Index Futures Contract Example

Index Futures Contract Example – Profit
Index > Contract Price = Buyer Profits
Index in September: 13,000

Contract Index: 12,513.50
Difference = 486.50
Profit = 486.50 * 25 EUR (Contract Size)

= 12,162.50 EUR

Calculating the Fair Value of an Equity Index Future
Carry Costs Carry Returns

Interest Coupons
Transport and Warehousing Dividends
Insurance Convenience (consumable assets)

Equity Index Futures – FTSE 100 Contracts
Decreasing Price

Calculating the Fair Value of an Equity Index Future
Rx N
Fair Value of the Future = Cash Index x 1 + – Dividends
360
• Fair Value of the Future = The value of the equity index future
based on the spot index plus carry costs less carry returns
• Cash Index = The term used to reflect the spot index. For the
S&P 500, it is called the S&P 500 Cash Index.
• R = Interest rate required (derived from yield curve)
• N = Number of days until expiration
• Dividends = Dividends realized until expiration (denoted as S&P
points)

Fair Value of Index Futures Example One
If today is July 14, 2024, what is the fair value for an S&P 500 index futures contract expiring on
September 20, 2024?
Rx N
Information: Fair Value of the Future = Cash Index x 1 + – Dividends
360
• S&P 500 Cash Index: 3,200
• Interest Rate: 0.30%
• Days Until Expiration: 68 (9 weeks, 5 days)
• S&P 500 Dividend Yield: 1.89%

Fair Value of Index Futures Answer One
September 20, 2024?
Rx N
360
• Days Until Expiration: 68 (9 weeks, 5 days) Convert to S&P Dividend Points:
Cash Index (3,200) x Dividend Yield (1.89%) = 60.48
68
60.48 S&P points/year x = 11.424
360
What would you do if the Equity Index
Future was trading at 3,200?
0.003 x 68
Fair Value of the Future = 3,200 x 1 + – 11.424 = 3,190.39
360

Index Arbitrage
Rich(+)/Cheap(-) = Futures Price – Fair Value of the Future

= 3,200.00 – 3,190.39 = 9.61 Rich
Index Arbitrage Opportunity: Index Futures Price ≠ Fair Value of the Future
If an equity index future is trading at a premium, it will trigger the bank to buy the underlying stocks in
the index and sell the index future.

Index Futures Calculations
Fair Future = Cash Index + Fair Value

= 3,009.74 – 11.48 = 2,998.26
Spread = Future Price – Cash Index

= 3,003.00 – 3,009.74 = -6.74
Fair Value = Fair Future – Cash Index

= 2,998.26 – 3,009.74 = -11.48
Rich(+)/Cheap(-) = Future Price – Fair Future

= 3,003.00 – 2,998.26 = 4.74 Rich

Index Futures Calculations Example
Verify that you can calculate the following:
• Fair Value
• Rich/Cheap

Index Futures Calculations Answer
Fair Value = Fair Future – Cash Index

= 2,986.19 – 3,009.74 = -23.55
Rich(+)/Cheap(-) = Future Price – Fair Future

= 2,993.75 – 2,986.19 = 7.56 Rich

Fair Value of Index Futures Exercise
December 20, 2024?
Rx N
360
• Days Until Expiration: 155 (22 weeks, 1 day)

Fair Value of Index Futures Exercise Answer
December 20, 2024?
Rx N
360
• Days Until Expiration: 155 (22 weeks, 1 day) Convert to S&P Dividend Points:
Cash Index (2,915) x Dividend Yield (1.52%) = 44.308
155
44.308 S&P points/year x = 19.077
360
0.0025 x 155
Fair Value of the Future = 2,915 x 1 + – 19.007 = 2,899.06
360

Interest Rate Futures and Forward
Contracts

Money Market Futures
Money market futures are futures based on short-term interest rates (STIR).
Parties use STIR The price of STIR

futures contracts futures is inverse
to take bets on to rates
the price

Fed Funds Futures Contract – Bloomberg Example
FF: Exchange Symbol

K: Delivery Month
0: Year
Fed Funds: Excess reserves which commercial banks keep on deposit

within the US Federal Reserve.
• Borrowed/lent between banks and other market participants
overnight.
• Short-term loans which are typically unsecured and carry low
interest rates.

Fed Funds Futures Contract – Contract Size

Fed Funds Futures Contract – Tick Size and Value
Normally:
Contract Size x Tick Size
= Value of 1.0 pt
Thus:
5,000,000 x 0.0025
= $12,500
But CME changed the

value to $4,167 per pt.

Fed Funds Futures Contract – Price and Contract Value
100 – 99.9250
= 0.075 or 7.5bps

Fed Funds Futures Contract – FOMC Meeting Schedule and Rates

Fed Funds Futures Contract – First and Last Trade

Futures Contract – Valuation
On the valuation date (May 29, 2020):
Contract Valuation 100 – EFFR = Price
Sum of daily EFFRs

in the month
Daily EFFR
# Days in the Month
Volume-Weighted Average
Banks & Broker-Dealers

Long Positions in Fed Funds Futures Contracts
A long position:
A trader that has bought now with the
expectation that the price will rise also
expects rates to fall.
Today One Month Later

Contract price: 99.90 Spot price: 99.95
Buy the future for 99.90 Implied rates have decreased by 5bps
Sell the future for 99.95

Short Positions in Fed Funds Futures Contracts
A short position:
A trader that has sold now with the expectation
that the price will fall also expects rates to rise.
Today One Month Later

Contract price: 99.95 Spot price: 99.90
Sell the future for 99.95 Implied rates have increased by 5bps
Buy the future for 99.90

Fed Funds Futures Contracts – Profit & Loss
Assume that at the beginning of May, you bought 10 May Fed Fund futures contracts of $5MM each at
99.90 (implied fed funds rate of 10bps).
At the end of May on the valuation date, the EFFR is 5bps which means the contract price is 99.95.
$10.4175 per Tick

Change 20 Ticks 10 Contracts x $208.35
20 Ticks x $10.4175
of 0.05 (1 Tick = 0.0025) = $2,083.50
= $208.35 per Contract
Buyer Seller
+$2,083.50 -$2,083.50
Clearing House

Forward Rate Agreements (FRA)
An FRA is a forward contract to exchange a payment based on the rate of interest at an agreed
future date.
• Over-the-counter (OTC) product (i.e., not exchange-traded)

• Used by borrowers (known as FRA buyers) to hedge against the risk of rising interest rates.
• Used by lenders (known as FRA sellers) to hedge against the risk of falling interest rates.
• Used by speculators looking to take a bet on the future direction of interest rates.
• Based on LIBOR or EURIBOR – generally traded on the future level of 3 or 6-month LIBOR.
• No transfer of principal.

FRA Example
ACME Corp Inc. needs to borrow USD $100MM for three months starting in one month’s time. ACME will
pay interest on this loan based on LIBOR.
ACME Corp is worried that interest rates are going to rise between now and when it needs to borrow
the $100MM in one month.
ACME Corp FRA broker

Asks for a quote in “1 x 4”
“One by four” is a 3-month FRA

1 month from now

FRA Exercise
Read the following FRA quotes and fill in the boxes.
Notation Effective or Termination or Underlying rate

Settlement Date Maturity Date from
from now now
1x7 1 month 7 months 6-month LIBOR
3x6 3 months 6 months 3-month LIBOR
6 x 12 6 months 6 months 6-month LIBOR

Forward Rate Agreements (FRA) – Timeline
Waiting Period (1 month)

1x4 FRA
Spot Date Fixing Date
t+2 t+2
Trade Date Settlement Date Maturity Date

“Forward Start”
Contract Period (3 Months)
The FRA ends at the settlement date when any payments are exchanged, discounted at the fixing
(settlement) rate.

FRA Example Continued
ACME Corp Inc. gets the following quote from an FRA broker:
ACME Corp FRA broker

Asks for a quote in “1 x 4”
“One by four” is a 3-month FRA

one month from now
Quote is US$ 1x4 – 3.00/3.25% p.a.
BID - ASK
3.00 - 3.25
ACME Corp buys an FRA at 3.25% on a notional principal amount of $100MM.

FRA Example Scenarios
Scenario A Scenario B
On the fixing date (one month later) 3- On the fixing date (one month later) 3-
month LIBOR is set a 3.35%. month LIBOR is set at 3.15%.
• ACME Corp makes a profit of 0.10% as it • ACME Corp takes a loss of 0.10% and must pay
receives the difference between LIBOR and the the FRA broker.
contract rate from the FRA broker.
• ACME Corp has to borrow at 3.15%.
• ACME Corp has to borrow at 3.35%.
• But the real cost of funding is: 3.15% + 0.10% =
• But the real cost of funding is: 3.35% - 0.10% = 3.25%.
3.25%.

Calculation of the FRA Payment
We entered a 1 x 4 FRA at 3.25% for $100MM. Imagine the settlement rate on the fixing date one
month from now is 3.35%.
The 3-month payment 90 x

0.10% x $100MM = $25,000
calculation: 360
The present value of $25,000

= $24,792.36
this payment: 90 x 0.0335
1+
360

FRA Payment Exercise
Large Corp Inc. will be borrowing $50MM in two months time for 6 months.
The FRA broker provides the following quote US$ 2x8 2.55/2.65% p.a.
Two months from now the LIBOR settlement rate is 2.80%.
What is the FRA payment?
Once you solve this question, download the answer key from the next lesson.

Intermediate: Futures & Forwards

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Intermediate: Futures & Forwards

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Intermediate Futures & Forwards

Corporate Finance Institute®

Corporate Finance Institute®

Common derivative contracts include forwards, futures, options, and swaps.

Forward Commitment Contingent Claims

Forwards Futures Swaps Options

Corporate Finance Institute®

8,000 barrels of oil

Corporate Finance Institute®

Corporate Finance Institute®

A futures contract is similar to a forward contract. It is an agreement to exchange an underlying

The major differences include:

01 Futures contracts are traded on exchanges rather than over-the-counter

02 Futures contracts have standardized contract terms

03 Futures contracts involve margins

Corporate Finance Institute®

Liquidity Leverage through margins

Corporate Finance Institute®

A futures contract is an agreement to exchange a commodity for a pre-specified price at a specified

Today Delivery Date

• Contract size: the defined volume • Physical delivery: commodity delivered in

Corporate Finance Institute®

Counterparty A Margin Call Counterparty B

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We are going to calculate the margin requirements

Oil Futures Contract

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Maintenance Margin: $3,000 x 10 contracts = $30,000

Day 1 Day 2 Day 3 (Expiration)

Corporate Finance Institute®

Corporate Finance Institute®

Strategy 1: Buy Now and Hold Strategy 2: Buy a Futures Contract

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Strategy 1: Buy Now and Hold Strategy 2: Buy a Futures Contract

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Action Cash Position

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Futures Price = Spot Price + Carry Costs – Carry Return

Carry Costs Carry Returns

• Premium to hold the underlying commodity

Corporate Finance Institute®

Futures Price = Spot Price + Carry Costs – Carry Return

Contango Market: Carry Cost > Carry Return

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Commodity futures are typically

Corporate Finance Institute®

Corporate Finance Institute®

Equity index futures are typically

Corporate Finance Institute®

Corporate Finance Institute®

Futures Price = Spot Price + Carry Costs – Carry Return

Corporate Finance Institute®

Futures Price = Spot Price + Carry Costs – Carry Return

Strategy One (Cash and Carry)

Expenses Cash Position

Price/Oz: $169,000/100 = $1,690

Corporate Finance Institute®

Strategy Two (Buy a Future)

• Buy a futures contract

Cost = Futures Contract Price

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Arbitrage Strategy Cost

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