Cash Settlement Research Articles

The Impact of Margin Interest on the Valuation of Credit Default Swaps

Virtually all credit default swaps (CDS) are collateralized with a daily cash settlement of the variation margin equal to the change in their mark-to-market values. We show how the interest on the variation margin (also called price alignment interest) affects the value of CDS. Specifically, we show that all CDS can be valued as the expected net present value of the premium and default contingent payments by using the same risk-neutral probability measure but different discounting rates determined by the margin interest rate (i.e., the interest rate used to compute price alignment interest) on the individual CDS. For example, if the margin interest rate is fed funds, then the discounting should be done on the overnight indexed swap (OIS) curve, and if there is no margin interest, then there should be no discounting. We show that arbitrage opportunities can occur if this valuation approach is not used. Finally, using observed market prices, we numerically demonstrate meaningful differences in CDS mark-to-mark values when the OIS curve is used for discounting instead of the customary LIBOR curve.

Common Mischaracterizations of Early English Translations of Exquemelin's Buccaneers of America

SCHOLARS tell a common story about early English translations of Alexandre Olivier Exquemelin’s Buccaneers of America (1678) and the steps Sir Henry Morgan took to defend his character in response to them. According to most accounts, as soon as William Crooke and Thomas Malthus published their independent translations in 1684, Morgan became incensed at how he was characterized and filed a lawsuit through his lawyer John Greene, charging libel against both booksellers. Morgan prevailed, winning a cash settlement from each, and Crooke and Malthus were forced to publish new, amended editions immediately with apologetic prefaces flattering to Morgan. This account, with variations, has persisted through the decades and in the most recent work on Morgan; it is, however, incorrect in important details.1 The literature on Morgan and his libel suit generally make two types of errors. First, it confuses the chronological order of editions and legal actions, and secondly, it conflates two separate disputes—the one that occurred between Morgan and the publishers, and a different conflict that occurred among the book publishers themselves and which preceded that libel suit. Because of these errors, scholarship has repeatedly mischaracterized the prefatory material attached to the early English editions and has misrepresented the early English publication history of Exquemelin’s Buccaneers of America.

How Does Dipping into Your Pension Affect Your Retirement Wealth?

Although pensions, both public and private, are intended to provide income during retirement, a growing number of American workers receive part or all their employer-provided pensions in the form of a cash settlement, called a lump-sum distribution, when they change jobs. They have many choices of what to do with that money: for example, they can roll it over into an Individual Retirement Account (IRA), spend the money or pay or debt, transfer it to the pension plan of a new employer, or even leave the money with the old employer's pension plan. Policymakers are concerned that workers who spend their pension distributions on current consumption are depriving themselves of the financial resources they will need for retirement. This policy brief describes some results from an ongoing study on the long-term economic consequences of lump-sum pension distributions. The study uses detailed information on employment histories, pensions, and wealth from Wave 1 (1992) of the Health and Retirement Study (HRS), a nationally representative survey of individuals between the ages of 41 and 61.

Pricing and upper price bounds of relax certificates

Relax certificates are written on multiple underlying stocks. Their payoff depends on a barrier condition and is thus path-dependent. As long as none of the underlying assets crosses a lower barrier, the investor receives the payoff of a coupon bond. Otherwise, there is a cash settlement at maturity which depends on the lowest stock return. Thus, the products consist of a knock-out coupon bond and a knock-in claim on the minimum of the stock prices. In a Black-Scholes model setup, the price of the knock-out part can be given in closed (or semi-closed) form in the case of one or two underlyings only. With the exception of the trivial case of one underlying, the price of the knock-in minimum claim always has to be calculated numerically. Hence, we derive semi-closed form upper price bounds. These bounds are the lowest upper price bounds which can be calculated without the use of numerical methods. In addition, the bounds are especially tight for the vast majority of relax certificates which are traded at a discount relative to the corresponding coupon bond. This is also illustrated with market data.

Multinationals and futures hedging: An optimal stopping approach

This paper examines the optimal design of a futures hedge program for a risk-averse multinational firm (MNF) under exchange rate uncertainty. All currency futures contracts are marked to market and require interim cash settlement of gains and losses. The MNF commits to prematurely liquidating its futures position on which the interim loss incurred exceeds a threshold level (i.e., the liquidation threshold). When the liquidation threshold is exogenously given, we show that the MNF optimally opts for an under-hedge (an over-hedge) should the futures exchange rates be not too (sufficiently) positively autocorrelated. When the liquidation threshold is endogenously determined, we show that the MNF voluntarily chooses to prematurely liquidate its futures position only if the futures exchange rates are positively autocorrelated. In the case that the futures exchange rates are uncorrelated or negatively autocorrelated, the MNF prefers not to commit to any finite liquidation thresholds.

Institutional innovation in less than ideal conditions: Management of commons by an Alaska Native village corporation

Alaska Natives have experienced less than ideal conditions for engaging in management of their homeland commons. During the first 100 years after the Treaty of Cession of 1867, Alaska Natives received limited recognition by the United States. The Alaska Native Claims Settlement Act of 1971 (ANCSA) was signed into law by President Richard Nixon after tedious negotiations by Alaska Natives, the United States Congress, and special interest groups. As part of the settlement, 12 regional corporations and over 200 village corporations were established to receive fee title to 40 million acres of land and a cash settlement of $962.5 million for lands lost. This arrangement has been considered by some as an act of social engineering to assimilate Alaska Natives into a capitalist economy. In spite of the goal of assimilation, Alaska Natives have utilized ANCSA to strengthen their indigenous identity and revitalize their cultural traditions. This paper examines the innovative efforts of Alaska Natives to successfully manage their commons despite the introduction of new and foreign institutions. Since the passing of ANSCA, Alaska Natives have cultivated good skills to navigate and modify legal systems and engage bureaucracies with considerable success. More than 36 years after the passage of ANCSA, most Alaska Native homelands remain intact in ways not previously imagined. Village corporations have used a number of legal methods to allocate land to shareholders, manage ownership of stocks, and contribute to the Alaska economy. ANCSA provided no special aboriginal rights for harvesting and management of fish and wildlife. Resultant rural-urban conflicts have been confronted with a novel mix of agency-Native cooperation and litigation. Although aspects of the arrangement are not ideal, the conditions are not hopeless. Our paper explores the hypothesis that while formal institutions matter, informal institutions have considerable potential to generate innovative solutions that overcome formal institutional shortfalls. We draw on the experiences of Native corporations in several regions of Alaska, with a focus on Bean Ridge Corporation (BRC), the village corporation which owns lands in and around the community of Manley Hot Springs, Alaska. Programs to distribute corporate earnings, address trespassing, and maintain cultural traditions are described.

ISDA's evolving auction methodology: cash settlement of loan credit default swaps

The deterioration in the credit markets over the past 18 months, and especially in more recent times, has caused investors to focus on the operational and counterparty risks embedded in the closely related credit derivatives market. In particular, buyers of credit default protection increasingly worry about their ability to realise the “recovery value” of the assets underlying the derivative transaction from their counterparty promptly after a credit default.

Production, liquidity, and futures price dynamics

AbstractThis study examines the optimal design of a futures hedge program for the competitive firm under output price uncertainty. All futures contracts are unbiased and marked to market in that they require interim cash settlement of gains and losses. The futures price dynamics follows a first‐order autoregression with a random walk serving as a special case. The firm's futures hedge program is constituted of an endogenous provision for premature termination, which depends on how the futures prices are autocorrelated. Succinctly, the firm voluntarily commits to premature liquidation of its futures position on which the interim loss incurred exceeds a predetermined threshold level if the futures prices are positively autocorrelated. In this case, the liquidity constrained firm optimally opts for an over‐hedge if its preferences exhibit either constant or increasing absolute risk aversion. If the futures prices are uncorrelated or negatively autocorrelated, the firm prefers to be liquidity unconstrained and thus adopts a full‐hedge to completely eliminate the output price risk. © 2008 Wiley Periodicals, Inc. Jrl Fut Mark 28:749–762, 2008

Inefficient Stock Market Generated by Adverse Information

This paper aims to search the high volatility of stock prices in stock market crises produced by adverse information, throughout investigating the links between stock price volatility and the institutional features of the major stock exchanges as exist in practice. The study finds that the causes of stock market crises reside in First, the noise trading and overreaction of stock traders. Second the increasing linkage among the international stock markets. Third, the effect of the option markets. Fourth some of the present institutional features of the stock market structure. The paper suggests reforms to curb the possible causes of stock market instability. The reforms relate to regulations concerning bearer share certificate, outside stock trading, controlling of high price fluctuations, price quotations, and stock dealing methods and cash settlement systems. In addition, the paper discussed the holding own share's model as a new financial instrument to support the stock market price in case of market crises.

Hedging Effectiveness with Physical Delivery and Cash Settlement at Indian Commodity Futures Market: An Empirical Comparison Analysis

In the globalization era, competitive market requires efficient market dynamics challenging the asymmetric information flow on market activities. Out of several, the 'hedging' has the significant role in stabilizing the market, realizing market efficiency and enabling minimization of risk and thus maximizing utility. Effective hedging ensures the reliable and sustainable benefit at both the physical delivery and cash settlement at Indian commodity futures market. In addition, applying multivariate GARCH (1, 1) methodology these dynamics could be ascertained accurately.

The mosul question and the Turkish republic: Before and after the frontier treaty, 1926

The Mosul Vilayet was part of the Ottoman Empire until the end of the First World War. Following the war it was occupied by Britain and the Vilayet became the bone of contention between the Ottoman Empire and Britain. After the War of Independence, the new Turkish Republic considered Mosul one of the crucial issues determined in the National Pact. Despite constant resistance, Britain managed to bring the issue into the international arena, scaling it down to a frontier problem between Turkeyand Iraq. In the Turkish historical literature, the Mosul QuestIon has been studied until the Frontier Treaty (1926). According to these studies, the Turkish government, in accordance wIth the exchange of letters annexed to the Frontier Treaty (1926), agreed to receive a fixed q.sh settlement of 500,000 pounds, rather than calculating the amount on a ten percent basis. That is to say, the Turkish government received the 500 000 pounds and the folio of the Mosul Question was c1osed. But some findings proved that this was not the case. Some figures in the Turkish state budgets indicate that Turkey received payments on a ten percent basis instead of the fixed cash settlement. From 1931 to 1952 Turkey received royalty payments regularly. After 1952, two issues caused serious problems between Turkeyand Iraq; namely, the unpaid years and insufficient payments. In latter period, Turkey chose to pursue a conciliatory policyand the issue was pui aside for the purpose of establishing friendly relations with Iraq.

Multinationals and futures hedging under liquidity constraints

This paper examines the behavior of a multinational firm (MNF) under exchange rate uncertainty. The MNF has operations domiciled in the home country and in a foreign country. Each of these two operations produces a single homogeneous good to be sold in the home and foreign markets. To hedge the exchange rate risk, the MNF has access to an intertemporally unbiased currency futures market. All currency futures contracts are marked-to-market and thus require interim cash settlement of gains and losses. We impose a liquidity constraint on the MNF in that the MNF is forced to prematurely liquidate its futures position from which the interim loss exceeds a predetermined threshold level. If the MNF's utility function satisfies decreasing absolute risk aversion, we show that the MNF optimally opts for a short under-hedge. Furthermore, the MNF sells less (more) and produces more (less) in the foreign (home) country in response to the imposition of the liquidity constraint.

Availability and settlement of individual stock futures and options expiration-day effects: evidence from high-frequency data

This study examines whether the expiration-day effects of stock options traded in Australian Stock Exchange on return, volatility, trading volume, and temporary price changes of individual stocks vary with the availability and the settlement method of individual stock futures contracts. Using transaction data of the stocks that have both options and futures contacts from 1993 to 1997, we find that options expiration has significant effects on return and volatility of the underlying stocks in absence of individual stock futures. After introduction of a cash-settled stock futures contract, the effects decrease notably. However, the switch of a futures contract from cash settlement to physical delivery promotes the expiration effects on return and volatility and boosts temporary price changes on expiration days. Finally, options expiration has little effect on trading volume. Trading activity tends to behave normally regardless whether stock futures contracts are available or not.

Position limits for cash-settled derivative contracts

Cash settlement of derivative contracts makes them susceptible to manipulation by traders who expect to close large positions upon final settlement. Cash settlement also increases underlying volatility when hedgers unwind their hedges if they have no incentives to control their trading costs. Limits on the positions that traders can carry into final settlement can be used to mitigate associated economic inefficiencies when surveillance is insufficient. This article develops a model that regulators can use to set these limits that is based upon microstructure theory. The empirical findings indicate that existing position limits are largely inconsistent with those suggested by the model. © 2005 Wiley Periodicals, Inc. Jrl Fut Mark 25:945–965, 2005

Tax asymmetry and futures hedging under liquidity constraints

This paper examines the optimal futures hedging decision of a firm facing uncertain income that is subject to asymmetric taxation with no loss-offset provisions. All futures contracts are marked to market and require interim cash settlement of gains and losses. The firm is liquidity constrained in that it is forced to prematurely close its futures position on which the interim loss incurred exceeds a threshold level. The liquidity risk created by the interim funding requirement of a futures hedge is shown to proffer the firm perverse incentives, thereby making an under-hedge optimal. This under-hedging result holds irrespective of whether the firm is risk neutral or risk averse. Copyright © 2005 John Wiley & Sons, Ltd.

A survey on physical delivery versus cash settlement in futures contracts

A futures contract may adopt physical delivery or cash settlement to liquidate open positions after the maturity day. While traditionally physical delivery specification is favored, exchanges have recently turned to examine cash settlement possibilities. This paper summarizes current literature on settlement specifications with emphases on market manipulation, cash index construction, and hedging effectiveness comparisons.

Alternative settlement methods and Australian individual share futures contracts

Individual share futures contracts have been introduced in Australia since 1994. Initially, the contracts were settled in cash. In 1996, cash settlement was gradually replaced by physical delivery. This study investigates the effects of the settlement method change on Australian individual stock and its futures markets. Specifically, we examine whether return and volatility of each market, correlation between the two markets, basis behavior, and hedging performance of futures markets differ across cash settlement period and physical delivery period. We find that, after the switch from cash settlement to physical delivery, the futures market, the spot market, and the basis all become more volatile. However, each individual share futures contract becomes a more effective hedging instrument. The improvement in hedging effectiveness is particularly impressive for the most recently established individual share futures contracts.

Hedging, liquidity, and the competitive firm under price uncertainty

AbstractIn this paper, the behavior of the competitive firm under price uncertainty when the firm has access to an intertemporally unbiased futures market is examined. Futures contracts are marked‐to‐market and thus require interim cash settlement of gains and losses. The firm is subject to a liquidity constraint in that it is forced to prematurely close its futures position on which the interim loss incurred exceeds a threshold level. It is shown that the liquidity constrained firm optimally opts for an under‐hedge should it be prudent. Furthermore, the prudent firm cuts down its optimal level of output in response to the presence of the liquidity constraint. As such, the liquidity risk created by the interim funding requirement of a futures hedge adversely affects the hedging and production decisions of the competitive firm under price uncertainty. © 2004 Wiley Periodicals, Inc. Jrl Fut Mark 24:697–706, 2004

THE MOSUL QUESTION AND THE TURKISH REPUBLIC: BEFORE AND AFTER THE FRONTIER TREATY, 1926

The Mosul Vilayet was part of the Ottoman Empire until the end of the First World War. Following the war it was occupied by Britain and the Vilayet became the bone of contention between the Ottoman Empire and Britain. After the War of Independence, the new Turkish Republic considered Mosul one of the crucial issues determined in the National Pact. Despite constant resistance, Britain managed to bring the issue into the international arena, scaling it down to a frontier problem betvveen Turkey and Iraq. In the Turkish historical literatüre, the Mosul Question has been studied until the Frontier Treaty 1926 . According to these studies, the Turkish government, in accordance with the exchange of letters annexed to the Frontier Treaty 1926 , agreed to receive a fixed cash settlement of 500,000 pounds, rather than calculating the amount on a ten percent basis. That is to say, the Turkish government received the 500 000 pounds and the folio of the Mosul Question was closed. But some findings proved that this was not the case. Some fıgures in the Turkish state budgets indicate that Turkey received payments on a ten percent basis instead of the fixed cash settlement. From 1931 to 1952 Turkey received royalty payments regularly. After 1952, two issues caused serious problems betvveen Turkey and Iıaq; namely, the unpaid years and insuffıcient payments. In latter period, Turkey chose to pursue a conciliatory policy and the issue was put aside for the purpose of establishing friendly relations with Iraq

Options expiration effects and the role of individual share futures contracts

AbstractThis note examines options expiration effects in the presence of individual stock futures contracts with different settlement methods. It is found that the availability of the futures contracts attenuate the expiration effects on price volatility and trading volume of individual stocks. Also, the stock price tends to move up near expiration days after physical delivery replaces cash settlement. These results provide empirical support to the conjectures made in Corredor et al. (2001). © 2003 Wiley Periodicals, Inc. Jrl Fut Mark 23:1107–1118, 2003