is now valued 45 points lower than the purchase value, or in monetary
terms 90 half-points (called ticks) £5 or £450. In addition there is a
deposit, or initial margin, that needs to be paid of maybe £3000.
The speculator must pay to their broker this loss plus the deposit
tomorrow. Even worse, the next day the FTSE futures fall by 200
points to 5250, which equates to 400 ticks £5 £2000. Again this
must be settled with the broker the next day.
The speculator has accumulated a loss of £2450 in two days and
has to settle that loss plus they have to provide £3000 in cash or
acceptable collateral to cover the initial margin requirement.
So the speculator has the advantage of a very large exposure
gained at a fraction of the true cost but has, nevertheless, to provide
over £5000 in just two days to settle the deposit and losses.
Of course the index and the futures might have risen instead of
falling and the speculator now has a profit of £2450 but still has to
provide the deposit amount of £3000 in cash or collateral.
Futures clearing and settlement
The hedger and the speculator have entered respectively into a sale and
a purchase of futures contracts. In the above example each trade has
been made via a broker onto the Euronext.liffe market and will now be
cleared by the exchange clearing house, LCH.Clearnet.Clearnet.
Clearing houses serving derivative exchanges are what is called
central clearing counterparties. This means that at a point when
the transactions that have taken place on the exchange are regis-
tered, the clearing house becomes the counterparty to the trade
(Figure 4.3).
54 Clearing and settlement of derivatives
Member
A
Member
B
Clearing
house
Figure 4.3 Central Counterparty
Notes: In Figure 4.3, Member A trades with Member B on the exchange (dotted line). For a time
they have a direct counterparty risk. However, as the trade is registered (solid line) at the
clearing house, the counterparty changes to being the clearing house and the two members
no longer have a risk on each other. The process is called novation.
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