FRM Part I · FRM Exam Part I

Futures Markets for FRM Part I: Chapter Guide

A futures contract is a standardised, exchange-traded agreement to buy or sell an asset at a set price on a future date, with daily margining through a clearinghouse. To solve questions, identify the contract, compute the hedge ratio or margin flows, then check basis and contract size.

What this chapter covers

This chapter covers how exchange-traded futures work. You start with contract design and market structure. You then move to margin, daily settlement and the clearinghouse, which are the mechanics that remove most counterparty risk. Delivery, settlement methods and order types close the mechanics.

The second half is applied. You learn to hedge with futures, measure basis risk, and pick a hedge ratio. Stock index futures add beta hedging. Interest rate and Treasury futures add conversion factors, cheapest-to-deliver and duration-based hedging. The last topic deals with pricing, rolling and accounting issues.

The chapter links to the rest of the paper in several ways. Futures pricing builds on the cost-of-carry logic from the wider Financial Markets and Products material. Hedge ratios use the variance, covariance and regression tools from Quantitative Analysis. Clearinghouses and margining tie back to counterparty risk in Foundations of Risk Management, and duration hedging ties to bond valuation.

Futures questions are very testable because they mix a small amount of theory with short calculations: a margin call, a minimum-variance hedge ratio, the number of index contracts for a beta target, or a Treasury futures hedge. These are quick marks if your method is clean, and with 100 questions in 4 hours you can't afford to spend long on them. The concepts also feed other chapters, such as risk management of derivatives portfolios, so the effort pays back more than once. Because GARP publishes no pass mark, treat every standard calculation as a mark you should secure.

Futures Markets: topics in the order to study them

1Futures Contract Basics and Market StructureVocabulary first: contract size, long and short, open interest and how futures differ from forwards.
2Margin, Marking to Market and Daily SettlementThe core mechanic and the most common calculation: initial, maintenance and variation margin.
3Clearinghouses and Counterparty RiskExplains why margining works, using what you just learned about daily settlement.
4Delivery, Settlement and Order TypesFinishes the mechanics: physical versus cash settlement, delivery options and order instructions.
5Hedging with Futures and Basis RiskMoves from mechanics to use. Hedge ratio and basis risk are the base for the next two topics.
6Stock Index Futures and Beta HedgingApplies the hedge ratio idea with beta to equity portfolios.
7Interest Rate Futures and Treasury FuturesHarder material with conversion factors, cheapest-to-deliver and duration-based hedging; study it once hedging logic is firm.
8Futures Pricing, Rolling and Hedge Accounting IssuesTies pricing, rolling costs and accounting effects together once you know every product.

How to prepare Futures Markets

Plan for repeated short sessions. Learn the mechanics by working numbers, not by rereading.

Read the contract basics and write a one-page comparison of futures and forwards: trading venue, standardisation, margining, credit risk and delivery.
Work a margin account by hand over five days. Track daily gain or loss, balance, the maintenance level and the amount needed to restore initial margin.
Learn the hedge formulas: minimum-variance hedge ratio h* = ρ × σS ÷ σF, and number of contracts N* = h* × QA ÷ QF. Practise with different correlations and volatilities.
Practise beta hedging. To change beta from β to a target β*, use N = (β* − β) × P ÷ A, where A is the value of one futures contract's underlying exposure. A negative N means sell contracts. Check the sign every time.
For Treasury futures, learn the conversion factor and cheapest-to-deliver idea, then practise duration-based hedge ratios. Use your financial calculator for bond prices and yields.
Finish with timed mixed questions on pricing, rolling and basis. Log each error by cause: formula, sign, units or concept.

Common mistakes in Futures Markets

Restoring a margin account only to the maintenance level after a margin call
Fix: Write the rule on your formula sheet: the call brings the balance back to initial margin. Compute the deposit as initial minus current balance.
Getting the sign of the basis or the profit wrong for a long or short position
Fix: Use basis = spot − futures (the convention in Hull); check the definition given in each question. For each position, ask first who gains if the futures price rises, then calculate.
Using the wrong volatility ratio in the hedge ratio
Fix: Remember h* = ρ × σS ÷ σF: asset volatility on top, futures volatility below. Correlation only scales the ratio σS ÷ σF down, since ρ ≤ 1. So h* can exceed 1 if σS is greater than σF, even when correlation is high.
Forgetting contract size and multiplier when counting contracts
Fix: Always convert to the value of one contract, such as index level × multiplier, before dividing the exposure.
Buying instead of selling futures in a beta hedge
Fix: Reducing beta needs short futures and raising beta needs long futures. Confirm the sign against that rule before answering.
Treating futures as having no credit risk
Fix: Remember it reduces risk but does not erase it. Margin shortfalls, clearing member failure and liquidity strain on margin calls remain.

Last-day revision: Futures Markets

Futures are standardised and exchange-traded; forwards are customised and over the counter.
Marking to market settles gains and losses daily; the long gains when the futures price rises.
A margin call arises when the balance falls below maintenance margin; you must restore to initial margin, not just to maintenance.
The clearinghouse stands between buyer and seller, and margin plus default funds protect it.
Most futures positions are closed out before delivery; cash-settled contracts involve no physical delivery of the asset.
Basis = spot − futures (the convention in Hull; check the definition given in the question); basis risk is uncertainty in the basis when you close the hedge.
Minimum-variance hedge ratio h* = ρ × σS ÷ σF.
Beta hedge: N = (β* − β) × P ÷ A; negative means short futures.
Treasury futures: the short chooses the cheapest-to-deliver bond, using conversion factors.
Cost of carry for an asset with no income: F = S × e^(rT) under continuous compounding.
Rolling a hedge exposes you to the basis or spread between contract months.
A perfect hedge removes price risk only if asset, amount and timing match; otherwise basis risk remains.

Futures Markets practice questions

Futures Markets in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Futures Markets: frequently asked questions

How are futures different from forwards in the FRM exam?

Futures are standardised, trade on exchanges and are settled daily through a clearinghouse. Forwards are private, customised and usually settled at maturity, so they carry more counterparty risk. Expect questions on this contrast.

Which calculations come up most in this chapter?

Margin account balances and margin calls, the minimum-variance hedge ratio, number of contracts for a hedge, beta adjustment with index futures, and basic cost-of-carry pricing. Treasury futures hedges based on duration also appear.

Do I need a financial calculator for futures questions?

Most futures calculations are simple arithmetic. A calculator helps with exponentials in pricing, and with bond prices and yields in Treasury futures hedging. Practise on the calculator GARP permits.

How long should I spend on this chapter?

Spend enough time to work every standard calculation without notes. Margin, hedge ratios and beta hedging are quick to learn but need repetition. Treasury futures usually needs the most time.