10.6.3 Futures Exchange
Overview of Futures Exchange
A futures exchange is a financial market where individuals and entities can trade standardized futures contracts. These contracts oblige the buyer to purchase, or the seller to sell, an asset at a predetermined future date and price. The standardized nature of these contracts reduces complexity and increases liquidity in the market.
The Montréal Exchange
History and Function
The Montréal Exchange (MX) is one of the largest exchange houses in Canada and a pivotal platform for trading financial futures. It provides a market for trading derivatives, including futures and options, specifically focused on the following areas:
- Index Futures: These contracts are based on stock market indices, allowing investors to hedge or speculate on the future movements of indices.
- Government of Canada Bonds: Futures are available for co mparative maturities including two-year, five-year, and 10-year terms. This allows for risk management related to interest rate fluctuations.
- Bankers’ Acceptances: Fixed-income instruments used in money markets can be traded with futures contracts on the Montréal Exchange.
- 30-day Overnight Repo Rate: This refers to trading of the rate at which banks lend to each other on an overnight basis, providing liquidity management tools.
Key Concepts and Terms
Futures Contracts
Future contracts are standardized agreements to buy or sell an asset at a specific time in the future. These can be based on indices, securities, or commodities.
Index Futures
Index futures are contracts underwritten based on stock indices, allowing speculation on market movements. Common indices include the S&P 500 and TSX.
Government of Canada Bonds
These are debt securities issued by the government, which can be traded as futures on the Montréal Exchange to manage interest rate risks.
Bankers’ Acceptances
Short-term debt instruments guaranteed by commercial banks, commonly used to finance imports and exports.
30-day Overnight Repo Rate
The rate at which banks lend money to each other on an overnight basis, reflecting overall liquidity in the banking market.
Example: Calculating Futures Price
Calculation Using Cost-of-Carry Model
The cost-of-carry model is often used to determine the futures price. The formula can be expressed as:
$$
(F = S \times e^{(r + c - y) \times T})
$$
where:
- \(F\) = Futures price
- \(S\) = Spot price of the asset
- \(r\) = Risk-free rate
- \(c\) = Storage cost
- \(y\) = Convenience yield
- \(T\) = Time to maturity
Frequently Asked Questions
-
What is the purpose of futures contracts?
Futures contracts are primarily used for hedging risk and speculating on the price movement of assets.
-
How are index futures beneficial to investors?
Index futures provide a way for investors to bet on or hedge against movements in the overall stock market without having to own the underlying stocks.
-
Why would someone trade government bond futures?
Trading in government bond futures allows investors to manage interest rate exposure efficiently.
Additional Resources
Key Takeaways
- The Montréal Exchange lists financial futures such as index futures, bonds, and collateral instruments like Bankers’ Acceptances.
- Futures contracts help investors hedge risks and speculate on future price movements efficiently.
- Understanding key concepts like futures contracts, index futures, and the cost-of-carry model is crucial for leveraging opportunities in the futures market.
📚✨ Quiz Time! ✨📚
## What types of financial instruments are listed on the Montréal Exchange?
- [ ] Corporate bonds
- [ ] Municipal bonds
- [ ] Corporate equities
- [x] Financial futures
> **Explanation:** The Montréal Exchange lists financial futures, not corporate bonds, municipal bonds, or equities.
## Which financial futures does the Montréal Exchange offer contracts on?
- [ ] International equities
- [ ] Corporate bonds
- [ ] Real estate assets
- [x] Index futures
> **Explanation:** The Montréal Exchange offers contracts on index futures.
## What type of Government of Canada bonds are listed on the Montréal Exchange?
- [ ] Provincial bonds
- [ ] Municipal bonds
- [ ] Corporate bonds
- [x] Two-year, five-year, and 10-year Government of Canada bonds
> **Explanation:** The Montréal Exchange lists futures on two-year, five-year, and 10-year Government of Canada bonds.
## Which other financial instrument, apart from Government bonds, is listed on the Montréal Exchange?
- [ ] Mutual funds
- [ ] ETFs
- [ ] Real Estate Investment Trusts (REITs)
- [x] Bankers’ acceptances
> **Explanation:** The Montréal Exchange also offers contracts on bankers’ acceptances.
## What overnight rate does the Montréal Exchange have futures contracts on?
- [ ] Prime rate
- [ ] LIBOR
- [x] 30-day overnight repo rate
- [ ] Federal Funds rate
> **Explanation:** The Montréal Exchange offers futures contracts on the 30-day overnight repo rate.
## Why might an investor be interested in trading futures on the Montréal Exchange?
- [x] To hedge against interest rate risks or speculate on price movements
- [ ] To gain ownership in a corporation
- [ ] To receive dividend payments
- [ ] To invest in real estate
> **Explanation:** Investors use futures contracts to hedge against interest rate risks or to speculate on price movements.
## Which timeframe futures are available on Government of Canada bonds at the Montréal Exchange?
- [ ] Monthly and yearly
- [ ] Daily and weekly
- [ ] Every 6 months
- [x] Two-year, five-year, and 10-year
> **Explanation:** Futures on two-year, five-year, and 10-year terms of Government of Canada bonds are available.
## What is a banker’s acceptance?
- [ ] A type of loan agreement
- [ ] A type of equity security
- [x] A short-term debt instrument issued by a company that is guaranteed by a commercial bank
- [ ] A long-term government bond
> **Explanation:** A banker’s acceptance is a short-term debt instrument issued by a company and guaranteed by a commercial bank.
## Can an investor trade futures on international financial instruments directly on the Montréal Exchange?
- [x] No
- [ ] Yes
- [ ] Depends on the instrument
- [ ] Only during certain market conditions
> **Explanation:** The Montréal Exchange lists financial futures primarily on Canadian securities and instruments, not international ones.
## What kind of institutions are typically involved in futures trading on the Montréal Exchange?
- [x] Institutional investors and financial firms
- [ ] Retail investors only
- [ ] Small local businesses
- [ ] Non-profit organizations
> **Explanation:** Futures trading on the Montréal Exchange is typically done by institutional investors and financial firms.