Book contents
- Frontmatter
- Dedication
- Contents
- List of Tables, Figures and Boxes
- Foreword
- Preface to the First Edition
- Preface to the Second Edition
- Acknowledgements
- Part–I Introduction
- Part–II Forwards and Futures
- 3 Futures and Forwards
- 4 Futures Trading: Pricing and Hedging
- 5 Interest Rate Futures
- 6 Currency Futures
- 7 Futures on Equities
- Part–III Swaps
- Part–IV Options
- Part–V Other Derivatives and Derivative-like Instruments
- Part–VI Accounting, Taxation and Regulatory Framework
- Part–VII Portfolio Management and Management of Derivative Risks
- Bibliography
- Index
3 - Futures and Forwards
from Part–II - Forwards and Futures
Published online by Cambridge University Press: 02 August 2019
- Frontmatter
- Dedication
- Contents
- List of Tables, Figures and Boxes
- Foreword
- Preface to the First Edition
- Preface to the Second Edition
- Acknowledgements
- Part–I Introduction
- Part–II Forwards and Futures
- 3 Futures and Forwards
- 4 Futures Trading: Pricing and Hedging
- 5 Interest Rate Futures
- 6 Currency Futures
- 7 Futures on Equities
- Part–III Swaps
- Part–IV Options
- Part–V Other Derivatives and Derivative-like Instruments
- Part–VI Accounting, Taxation and Regulatory Framework
- Part–VII Portfolio Management and Management of Derivative Risks
- Bibliography
- Index
Summary
As pointed out in chapter 1, futures trading, or more accurately forward trading, was the first form of derivatives trading. This chapter reviews the basic concepts of futures trading – its functions, the mechanism by which risk is transferred, the role of speculation and related issues. At the outset, it is necessary to understand clearly what futures trading means.
Definitions
A forward contract is an agreement between two parties to buy or sell, as the case may be, a commodity (or financial instrument or currency or any other underlying) on a pre-determined future date at a price agreed when the contract is entered into.
The key elements are that:
• the date on which the underlying asset will be bought/sold is determined in advance; and
• the price to be paid/received at that future date is determined at present.
Example 3.1
In the month of August, a rice mill agrees to buy 2.35 tonnes of rice of IR-8 variety from X, a farmer, in the following February at a price of 38,000 per tonne. This is a forward contract. Note that the farmer will receive (and the mill will pay) 38,000 x 2.35 = 89,300 in February irrespective of whether the market price in February is 40,000 per tonne or 36,000 per tonne. According to its terms, this contract may or may not be transferable by the mill or the farmer to any other person and accordingly may be called a ‘transferable’ or a ‘non-transferable’ forward contract.
A futures contract is a contract to buy or sell, a standard quantity of a standardised or pre-determined grade(s) of a certain commodity at a pre-determined location(s), on a pre-determined future date at a pre-agreed price. If this definition is studied carefully, the differences between a futures contract and a forward contract become apparent:
a. There is no reference to an agreement ‘between two parties’ – this is because futures contracts are almost always entered into through an intermediary (the exchange or its clearing house) that acts as the buyer to each seller and seller to each buyer. This is illustrated below:
The absence of a one-to-one relationship between the buyer and seller also means that these contracts are freely transferable.
- Type
- Chapter
- Information
- Derivatives , pp. 37 - 50Publisher: Cambridge University PressPrint publication year: 2017