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Sem 5 Prep
← Money & BankingForwards, futures and margin

Formulas for this chapter

Forward payoff

Long: profit per unit = S(T) - F(0,T) Short: profit per unit = F(0,T) - S(T) Total = profit per unit x quantity

Any forward or futures profit question. Decide your side first: buying forward makes you the long, selling forward the short.

S(T)
Spot price of the asset at delivery
F(0,T)
Forward price agreed at the start, for delivery at T

Default-risk exposure on a forward

Exposure at time t = PV{ |F(0,T) - F(t,T)| }, 0 < t < T

When a question asks who has the incentive to default and how much is at stake. The defaulting party is the one for whom the contract is a liability.

F(t,T)
Today's forward price for delivery on the original delivery date T
PV
Present value, discounting from T back to t at the rate for that tenor

Margin account, one day at a time

Contract value = lot size x number of lots x price Initial margin = margin % x contract value MTM (long) = (today - yesterday) x quantity MTM (short) = (yesterday - today) x quantity Equity = previous equity + MTM + variation margin Call fires when equity < maintenance margin Variation margin = initial margin - equity

Every mark-to-market table. Work one row at a time and never skip the equity line, because the call is tested on equity, not on the price.

quantity
Units controlled: lot size times number of lots
maintenance margin
Minimum equity that must be kept in the account
variation margin
Top-up called for, sized to restore equity to the initial margin

Price move that triggers the first call

Cushion = initial margin - maintenance margin Adverse move allowed per unit = cushion / quantity

When asked how far the price can go before a margin call. Convert the equity cushion into a price move using the number of units, never the number of lots.

cushion
Equity available above the maintenance level
Step 1 of 29
The ideaTheory

Shaking hands on a price today

You want to buy a flat next January. The builder wants to sell it. Neither of you knows what flats will cost in January.

So you shake hands today on a price for January. No money moves now. In January you pay that price whatever the market says.

You have just written a forward contract. If flats get dearer you win, because you are paying the old price. If they get cheaper you lose. The builder's outcome is the exact mirror of yours.

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