I'm not understanding the part on margins, page 416 of 582. "For example, if the price of bond futures fell to £93,000 the following day, then you as the buyer would have made a loss of £1,000, whereas the seller would have made a profit of £1,000. You as the buyer would have £1,000 deducted from your margin account, and may have to top it up by paying the clearing house £1,000, and the seller’s margin account with the clearing house would increase by £1,000, which could be removed by the seller from the account." So the following day is the day after the agreement is made with the bond to be bought in 3 months time still. (At this point is the clearing house holding the bond that has been sold to it by the seller?) The price of the bond falls by 1000. An initial margin was deposited into the clearing house and 1000 of that initial margin (to be topped up if the initial margin was less than 1000) is removed to pay the clearing house as they're out of pocket 1000 as they're holding the bond? The buyer (also?) has to pay another 1000 to the seller's margin account? And then bother the clearing house and the seller are up 1000? So is the buyer in this case down by double whatever the decrease is in the bond price? Or have I misunderstood and the buyer pays the clearing house 1000 and this 1000 is then given to the seller's margin account? Thanks, the wording on this one isn't very clear to me.
Hi You are maybe thinking of a future as being something that it is not. For example you say "the clearing house is holding the bond .." The clearing house doesnt hold any bonds. The easiest way to think about it is to imagine a buyer A and a seller B and a clearing house C in the middle. A commits to buy a bond at price £102, for settlement in 3 months, and simultaneously the seller B commits to sell the bond in 3 month at £102. Neither have the bond. C steps into the middle and is counterparty to both trades. The next day the bond price has moved to £101 - ie its cheaper. A has a commitment to buy at £102 and its now £101 so that deal is standing on a £1 loss. This loss is deducted from the margin account which holds cash. B has a commitment to sell something at £102 which is now worth £101 - a deal that is on a profit of £1. that profit is credited to the margin account by the clearing house and everybody is happy. Including C who deducts a small fee for standing in the middle. Before the future expires, A will want to undertake a commitment to sell the bond to extinguish the buy trade, and likewise B will want to undertake a buy trade, to extinguish the open sell trade. Suppose this happens when the bond is trading at £98. Then A has bought at £102 and sold at £98 for settlement on the same day - both trades are cancelled, but A has lost £4 which has come out of their margin account. B has sold at £102 and then bought at £98, so again both trades are cancelled and nothing settles at the end of the 3 months. But B has made a profit of £4 which is deposited in their account. Noone trades the bond and noone ever held the bond, so there is no double loss. the clearing house C was always party to two equal and opposite trades so ran no price risk over the period. In the unlikely event that, at t=3 months, A actually wanted to buy the bond, the clearing house will have an open trade with someone that has committed to sell the bond. So at the end of the three months, A buys from the clearing house, but the clearing house also buys from the open sell contract, and so passes the bond straight through. I hope this helps. Its complex and tricky to get your head round sometimes.
How can seller B sell the bond if "neither have the bond", line 4? Do both A and B have their own margin accounts? Which C either takes from or adds to? C takes a small fee from both margin accounts? Both A and B then switch places and A becomes a seller of a bond they don't have (not necessarily selling it to B?) and likewise B becomes the buyer of a bond.
B will enter into a contract to sell the bond in the future. They don't have to exchange the bond at the point of entering the contract and therefore they don't require actual ownership of the bond. Correct. Two separate margin accounts, and the clearing house will require some fee for managing the process. This is how A and B can extinguish their commitment to the initial contract.
