Role of clearing house in transactions

Explain the convergence of futures and spot prices Spot price is the price of the commodity today Future price is the price of the commodity today for delivery at a future specified time Difference between spot and future price is the basis  Basis = Spot Price – Futures Price At maturity Spot Price = Futures Price since at maturity future price becomes the current spot price Arbitrage forces Spot Price = Future Price at maturity Describe the rationale of margin requirements and describe how they work Collateral placed on account that acts as a guarantee for a trade is known as Margin When a trader buys a future position the amount initially required to buy the futures is known as the initial margin The amount that a trader must maintain in his account on a day to day basis is the maintenance margin When the value of the asset drops and if the amount deposited by the trader falls below the maintenance margin the trader has to deposit an amount to bring up to the maintenance margin. This amount is called the variation margin Variation Margin =  Maintenance Margin – Current Value of Asset Describe the rationale of margin requirements and describe how they work Collateral placed on account that acts as a guarantee for a trade is known as Margin When a trader buys a future position the amount initially required to buy the futures is known as the initial margin The amount that a trader must maintain in his account on a day to day basis is the maintenance margin When the value of the asset drops and if the amount deposited by the trader falls below the maintenance margin the trader has to deposit an amount to bring up to the maintenance margin. This amount is called the variation margin Variation Margin =  Maintenance Margin – Current Value of Asset Describe the role of a clearinghouse in transaction Clearinghouse Guarantees all contracts are honored All trade are executed with clearinghouse as the opposite side of the transaction No issue of default of clearinghouse since margin amounts are posted by the trader to the clearinghouse Easy to reverse the position in the clearinghouse since trade are bought/sold to the clearinghouse and no contact necessary with any third party other than the clearinghouse All exchanges has clearinghouse  Collateralization Marked to market feature in Over the counter market (OTC) where everyday losses are settled in cash Reduces the credit risk in OTC market Reduces the credit risk in OTC market