● Standardizing Features
❖ Contract Size
❖ Delivery Month
● Daily resettlement
❖Minimizes the chance of defaultΥ●Initial Margin
❖ About 4-10% of contract value
❖ Cash or T-bills held in a street name at your brokerage
Underlying assets of future contracts: Shares, Stock Market Indices, Short-term interest rates, Medium- and long-term interest rates, Foreign exchange rates, Commodities.A futures contract represents a zero-sum game between a buyer and a seller.
▪ Gains realized by the buyer are offset by losses realized by the seller (and vice-versa).
▪ The futures exchanges keep track of the gains and losses every day. Futures contracts are used for hedging and speculation
▪ Hedging and speculating are complementary activities.
▪ Hedgers shift price risk to speculators.
▪ Speculators absorb price risk.
Hedger: Someone who bears an economic risk and uses the futures market or other derivatives to reduce that risk.Hedging is a prudent business practice; today a prudent manager has an obligation to understand and apply risk management techniques including the use of derivatives
Speculator: A person or firm who accepts the risk the hedger does not want to take. Speculators believe the potential return outweighs the risk.
The primary purpose of derivatives markets is not speculation. Rather, they permit or enable the transfer of risk between market participants as they desire.
Hedging and Speculation in Future contracts.Hedging : Generally conducted where a price change could negatively affect a firm’s profits