Futures contract

forward price or forward rate

Serious Information

A futures contract is a standardized contract, traded on the futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a pre-set price. The future date is called delivery date or final settlement date. The pre set price is called a futures price. The price of an underlying asset on the delivery date is called the settlement price.

A futures contract gives a holder the right and the obligation to buy or sell, which differs from an options contract, which gives the buyer the right, but not the obligation, and the option writer (seller) the obligation, but not the right. In other words, the owner of an options contract can exercise (to buy or sell) on or prior to the pre-determined settlement/expiration date. Both parties a "futures contracts" must exercise the contract, buy or sellon the settlement date. To exit the commitment, the holder of a futures position has to sell his long position or buy back his short position, effectively closing out the futures position and its contract obligations.

A derivative is a generic term for specific types of investments from which payoffs over time are derived from the performance of assets (such as commodities, shares or bonds), interest rates, exchange rates, or indices (such as a stock market index, consumer price index (CPI) or an index of weather conditions). This performance can determine both the amount and the timing of the payoffs. The diverse range of potential underlying assets and payoff alternatives leads to a huge range of derivatives contracts available to be traded in the market. The main types of derivatives are futures, forwards, options and swaps. It is possible for companies to use derivatives to outlay risks in their business. For instance oil companies can buy derivatives to guard against the risk of prices lowering. These would be put under the classification of Energy & Energy Derivatives & Energy Risk Management

Futures contracts, or simply futures, are exchange traded derivatives. The exchange acts as counterparty on all contracts, sets margin requirements, etc.

While futures and forward contracts are both a contract to trade on a future date, key differences include:

Futures are traded on an exchange
Futures are highly standardized
The price at which the contract is finally settled is different:
Futures are settled at the settlement price fixed on the last trading date of the contract
Forwards are settled at the forward price agreed on the trade date
The credit risk of futures is much lower than that of forwards:
The profit or loss on a futures position is exchanged in cash every day. After this the credit exposure is again zero.
The profit or loss on a forward contract is only realised at the time of settlement, so the credit exposure can keep increasing
In case of physical delivery, the forward contract specifies to whom to make the delivery. The counterparty on a futures contract is chosen randomly by the exchange.
In a forward there are no cash flows until delivery, whereas in futures there are margin requirements and periodic margin calls.

Although the value of a contract at time of trading should be zero, its price constantly fluctuates. This renders the owner liable to adverse changes in value, and creates a credit risk to the exchange, who always acts as counterparty. To minimise this risk, the exchange demands that contract owners post a form of collateral, in the US formally called performance bond, but commonly known as margin.

Initial margin is paid by both buyer and seller. It represents the loss on that contract, as determined by historical price changes, that is not likely to be exceeded on a usual day's trading.

Margin-equity ratio is a term used by speculators, representing the amount of their trading capital that is being held as margin

Return on margin (ROM) is often used to judge performance because it represents the gain or loss compared to the exchange’s perceived risk as reflected in required margin

Futures traders are traditionally placed in one of two groups: hedgers, who have an interest in the underlying commodity and are seeking to hedge out the risk of price changes; and speculators, who seek to make a profit by predicting market moves and buying a commodity "on paper" for which they have no practical use.

All futures transactions in the USA are regulated by the Commodity Futures Trading Commission (CFTC), an independent agency of the US Government. The Commission has the right to hand out fines and other punishments for an individual or company who breaks any rule. Although by law the commission regulates all transactions, each exchange can have their own rule, and under contract can fine companies for different things or extend the fine that the CFTC hands out.
FIA

FIA is the only association representative of all organizations that have an interest in the futures market. FIA has more than 180 corporate members, reaching thousands of industry participants.

The jon of FIA is to

To provide a means for the exchange of ideas and to work with commodity exchanges for the promotion and preservation of free marketing and for the good of customers and the general public.
To cooperate with the commodity exchanges in the maintenance of a high standard of ethics and to insure a high quality of service to the public.
To make efforts to bring the Clearing Associations of all the commodity exchanges in New York City under one operating management, and to eventually bring all the commodity exchanges in New York under one roof.
To enlist the cooperation of commodity exchanges and to obtain uniformity in rules, particularly as they relate to transferable notices and to obtain uniformity in other By-Laws insofar as possible.
To study ways and means of reducing costs of doing commodity futures business and to increase the volume of trading from domestic and foreign sources.
To eliminate the abuses of credit rules.
To develop ways and means for protection against spurious and fictitious warehouse receipts.
To take concerted action to prevail upon all commodity exchanges to establish equitable procedures for members to vote.
To assemble and disseminate information of value to its members.
To observe proposed legislation in Congress and in the several State legislatures and to mobilize support for proposals designed to promote the free marketing system and to preserve the sanctity of the futures contract.
To cooperate with commodity exchanges and member firms in educational campaigns of a worldwide nature.
It is the aim of our association to broaden its membership to include commodity exchange firms in all areas of our country.

forward price or forward rate is the agreed upon price of an asset in a forward contract. Using the rational pricing assumption, we can express the forward price in terms of the spot price and any dividends etc., so that there is no possibility for arbitrage.

Trivia
Foreign names for future contract

Germany = Future

France = Marché à terme

Spain = Contrato de futuros

Links on websites on subject

http://www.federalreserve.gov/Boarddocs/testimony/2000/20000621.htm Testimony of Chairman Alan Greenspan on Federal Reserve Board's views on the Commodity Futures Modernization Act of 2000

http://www.ise.ie/index.asp The home page of Irish stock exchange

http://www.nasdaq.com/ The homepage of the stock exchange

http://www.cityequities.com/
http://www.moneyweek.com

government_bond information

foreign terms for the English word "contract"

contratto = Italy

Vertrag = German

Other Lonympics sites