Assignment 2: Valuation Of Futures Contracts Assume Today's
Assignment 2 Valuation Of Futures Contractsassume Todays Settlement
Assignment 2: Valuation of Futures Contracts Assume today’s settlement price on a CME Eurodollar futures contract is $1.3140/ED. You have a short position in one contract. Your performance bond account currently has a balance of $1,700. The next three days’ settlement prices are $1.3126, $1.3133, and $1.3049. In a 3-4 page paper, calculate the changes in the performance bond account from daily marking-to-market and the balance of the performance bond account after the third day (show your calculations). How would your results change assuming you have a long position in the futures contract? Describe three factors that might affect the financial results of a firm conducting business internationally which could ultimately impact the performance bond account. Use the following file naming convention: LastnameFirstInitial_M2_A2.doc. For example, if your name is John Smith, your document will be named SmithJ_M2_A2.doc.
Paper For Above instruction
Futures contracts are standardized agreements to buy or sell an underlying asset at a predetermined price at a specified future date. The process of daily marking-to-market ensures that gains and losses are settled daily, affecting the performance bond account of traders. This paper critically examines the valuation of futures contracts over three days, emphasizing the impact of the prices on a trader’s performance bond, considering both short and long positions, and discusses three factors influencing a firm's international financial results that impact their performance bond accounts.
Introduction
Futures markets serve as vital tools for hedging and speculation, allowing participants to manage price risks associated with underlying assets. The CME Eurodollar futures contract, which derives its value from the 3-month U.S. dollar interest rate, plays a crucial role in financial strategies. Accurate valuation and understanding daily settlement processes are essential for traders to manage their margin accounts effectively. This paper explores the valuation process over a series of days, analyzing how gains and losses from fluctuations in futures prices affect the margin account, and highlights the differences between short and long positions. Additionally, it discusses external factors that influence a firm's international financial results, which can indirectly impact the performance bond account.
Valuation of Futures Contracts and Daily Marking-to-Market
On the initial day, the settlement price is $1.3140 per Eurodollar futures contract. With a short position, the trader benefits when prices decline and suffers when prices rise. The performance bond account starts with a balance of $1,700. The daily gain or loss per futures contract is calculated using the price change multiplied by the contract multiplier, which is typically standardized (for Eurodollar futures, the dollar value change per basis point is $25). Since the prices are quoted as interest rates, the dollar value of the price change affects the margin.
The first day's settlement prices decline from $1.3140 to $1.3126, resulting in a price change of -0.0014 (because 1.3126 - 1.3140). For a short position, a decrease in price is favorable, resulting in a profit:
- Profit/Loss = Price Change * Contract Multiplier
- Assuming a contract multiplier of $25 per basis point:
- Change in price = 0.0014
- Profit = 0.0014 * $25 = $0.035
The account increases by $0.035, updating the performance bond account to:
- New Balance = Initial Balance + Profit = $1,700 + $0.035 ≈ $1,700.04
On the second day, the settlement price moves to $1.3133, a change of -0.0003 from the previous day:
- Profit/Loss = -0.0003 * $25 = -$0.0075
The account decreases by $0.0075, updating to:
- New Balance ≈ $1,700.04 - $0.0075 ≈ $1,700.0325
On the third day, the settlement price drops further to $1.3049, a change of -0.0084 from the previous day:
- Profit/Loss = -0.0084 * $25 = -$0.21
The performance bond account decreases by $0.21:
- Final Balance ≈ $1,700.0325 - $0.21 ≈ $1,699.82
Implications for a Long Position
Had the trader held a long position instead, the gains and losses would be inverted with respect to price movements. For example, on the first day, the price decreased, resulting in a loss for a long position, whereas a short position would benefit. The calculations follow the same process, but the impact of price changes switches signs. Specifically, a price decrease benefits the short position and disadvantages a long position, illustrating the opposite outcomes in gains and losses.
Factors Affecting International Business and Their Impact on Performance Bonds
Several external factors can influence a firm’s financial results in international markets, ultimately affecting the performance bond account. These include exchange rate volatility, geopolitical risks, and international interest rate differentials.
- Exchange Rate Volatility: Fluctuations in currency exchange rates impact the value of foreign transactions, profits, and costs. Unpredictable currency movements can result in unexpected gains or losses, affecting a firm’s overall financial stability and margin requirements.
- Geopolitical Risks: Political instability, trade tensions, and sanctions can disrupt international operations and financial arrangements. These risks may cause sudden market movements requiring adjustments in margin and impacting a firm’s ability to maintain adequate performance bonds.
- International Interest Rate Differentials: Changes in global interest rates influence borrowing costs and investment returns, affecting a firm's financial leverage and profit margins. Such fluctuations can alter the risk profile, leading to adjustments in margin requirements or performance bonds.
Understanding these factors is vital for firms engaged in international trade, as they influence not only operational risk but also the financial safeguards necessary to mitigate potential losses.
Conclusion
The valuation of futures contracts through daily marking-to-market significantly impacts traders’ performance bond accounts. As demonstrated, price movements directly affect the margin, with short and long positions experiencing opposite outcomes. External factors such as exchange rate movements, geopolitical risks, and global interest rates can complicate international operations and influence margin requirements. Managing these risks effectively is essential for firms to maintain financial stability and optimize their market positions. Analyzing daily market movements and understanding external influences enable traders and firms to better navigate the complexities of futures trading and international finance.
References
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