Case Objectives

To understand the relationship between spot and forward stock index prices.  To examine the potential impact that opening a forward market has on spot prices.

Case description

# Markets

The opening screen appears as follows.  The markets are described below.

Market 1 is called “Index A.”  This market trades a basket of stocks that exactly replicates a stock index called A.  At the end of the year this basket is marked to the realized value for stock index A.  Market 2 is called “Index B.”   This security is also a basket of stocks that exactly replicates a stock index called B.  Again at the end of the year this basket is marked to the realized value for stock index B.  Both markets A and B are spot markets and the stock indices A and B are identical except for the fact that their realizations are completely independent.  That is, if A is high then B can be any of the feasible values provided below.

Marked Value for Index A and Index B

The set of possible end of year realizations for each stock index are: {7900, 12100}.  Each realization is equally likely and the realization for index B is independent of the realization for index A.

Market 3 is a forward contract defined directly on index B.  It is cash settled at the end of the year and is quoted so that 1 forward contract corresponds to 1 unit of index B.

Market 3:  Forward Contract Long Forward Contract Example

Suppose you could buy or sell the forward contract at 10,000 during trading (day 1 of the year) and your current position in Index forwards is zero.  If you buy 1 unit of the forward contract you are now long one contract and the following transactions result:

Trading Day 1 of the Year:  Cash balance is not affected by buying the forward contract (i.e., zero cash is exchanged at the time of the trade).  Units balance for the forward contract increases by 1 (so current balance is +1 to reflect the long position).

End of the Year:  You are obligated to settle the forward contract at the price agreed to at the time of trade (e.g., 10,000 in current example).  Cash is reduced by 10,000 and in exchange you receive 1 unit of the underlying index B.  This has a realized value = ST.  So the net cash transferred into or from your cash account is:  ST – 10000.

Market 3:  Forward Contract Short Forward Contract Example

Suppose you could buy or sell the forward contract at 10,000 during trading (day 1 of the year) and your current position in Index forwards is zero.  If you sell 1 unit of the forward contract you are now short one contract and the following transactions result:

Trading Day 1 of the Year:  Cash balance is not affected by selling the forward contract (i.e., zero cash is exchanged at the time of the trade).  Units balance for the forward contract decreases by 1 (so current balance is -1 to reflect the short position).

End of the Year:  You are obligated to settle the forward contract at the price agreed to at the time of trade (e.g., 10,000 in current example).  Cash is increased by 10,000 and in exchange you must give up 1 unit of the underlying index B.  This has a realized value = ST.  So the net cash transferred into or from your cash account is:  10000 - ST.

It is your task, as part of the trading crowd, to discover prices for the spot and forward markets during the first day's trading.   A trading session consists of multiple independent trials.  Your trading bonus is cumulated across trials.

Your aim is to make as much money as you can and your trading bonus = 0.0001*total end of year market cash.

Next click on the button Find Excel Workbooks and then select the work book you want to link to.  Be sure to link Market Data and Trading History to two different sheets.  Then click OK.  The link is automatically maintained for you in real time.

Step 2:  The fixed spreadsheet cell conventions

If you choose to create a spreadsheet support system for this trading case the following cell information is relevant:

Suppose you link to Sheet 1 and sheet 2 as per screen shot below.  Sheet 1 maintains a real time link to your trading screen.  Spreadsheet Cols run from A (blank), B (Security), C (Bid), D (Bid Qty) etc., and rows run from 1 (Headings), 2 (Security 1), 3 (Security 2), 4 (Security 3) etc., for all securities in the case and then followed by your cash balance.

The above cells are fixed and general across FTS cases.  Once you have linked to your spreadsheet (which you can do via the file menu item in the FTS Trader), the first security’s bid comes into cell C2, and so on up until the VWAP (current volume weighted average price of trades).

The details for the second sheet which contains your personal trading diary are provided below: