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Hi, i am currently reading a book "oil 101" and there is a section i do not understand and i was hoping someone could shed some light on it for me.
"An important difference between exchange-traded futures contracts and non-exchange traded OTC contracts are that oil futures contract cash flows are not discounted for time-value, whereas OTC swaps are discounted."
Is someone able to elaborate on the above?
Rgds
Fraz
Can you help answer these questions from other members on NexusFi?
With a future you agree to buy or sell a commodity at a given expiry.
With a swap you are exchanging cash flow streams, including for example future dividend payments (less applicable to oil).
The big difference is that with a future the daily difference is added or deducted in your account at daily settlement. With a swap this difference is only settled at one or more payment periods (a swap can be a single payment) and that future settlement will be discounted for time value because the time the payment is delayed has a certain value.
Worth adding that the book your reading is 8 years old, and everything changed with Dodd-Frank and few years back. True OTC swaps rarely trade now, outside of producers hedging with banks that are on their credit revolver. I say "True" because the products do still trade OTC but are then cleared through CME or ICE. Of course once they are cleared they are margined and hence cash flows are no longer discounted. Example products are CME : WTI Financial Futures and ICE : WTI 1ST LINE FUTURE. Both of these have open interest in the hundreds of thousands but don't trade electronically.
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Yes. One of things Dodd-Frank wanted to achieve was greater transparency of what deals were out there between companies. It brought in such stringent requirements for reporting of [AUTOLINK]OTC[/AUTOLINK] Non-cleared trades that almost everything became cleared. This had the effect of greatly reducing counterparty risk, and greatly increased capital efficiency.
