Chapter 8 page 4 can you explain on the term margin I actually dont quite understand the example if the price of bond future drop the buyer experience loss,and why buyer was deducted the amount on the margin account and why is there a need to top it up ? and why the increase amount in seller account could be removed by seller ? Can you further explain on notional stock? Under bond future why say there is linkage between future and cash market? How is the delivery of bond work by the way ? and the party could choose which bond to deliver ? Why is this so?
Hi Let's deal with the term 'margin' first. There are two types: initial margin and variation margin. For a future, which is exchange-traded, these margin payments protect the exchange against the credit risk it is exposed to (if any trader fails to settle). The combination of initial and variation margin covers the current negative value of any losses on open contracts plus an extra amount (essentially a 'deposit') to cover possible future losses over the next day. For the bond future in the example, the buyer has agreed to pay 94k for a bond in 3 months time. If the price then drops to 93k the buyer has made a loss (they are obliged to pay 94k for something now priced at 93k) and so, as their losses have gone up, they need to pay more margin. The seller is in the opposite position. Hope this helps Lynn
