Forwards and Futures. 62. Forwards and futures entail the obligation to deliver or take delivery on a specified expiration date of a defined quantity of an underlying asset at a price agreed. Futures are standardised contracts traded on an Exchange while forwards are traded over-the-counter. Forwards and futures may involve high degree of risks.
Forwards and Futures. Basis Forward Contract Futures Contract Definition A forward contract is an agreement between two parties to buy or sell an asset (which can be of any kind) at a pre- agreed future point in time at a specified price. A futures contract is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a specified price. Structure & Purpose Customized to customer needs. Usually no initial payment required. Usually used for hedging. Standardized. Initial margin payment required. Usually used for speculation. Transaction method Negotiated directly by the buyer and seller Quoted and traded on the Exchange Market regulation Not regulated Government regulated market (the Commodity Futures Trading Commission or CFTC is the governing body) Institutional guarantee The contracting parties Clearing House Risk High counterparty risk Low counterparty risk Guarantees No guarantee of settlement until the date of maturity only the forward price, based on the spot price of the underlying asset is paid Both parties must deposit an initial guarantee (margin). The value of the operation is marked to market rates with daily settlement of profits and losses. Contract Maturity Forward contracts generally mature by delivering the commodity. Future contracts may not necessarily mature by delivery of commodity. Expiry date Depending on the transaction Standardized Method of pre- termination Opposite contract with same or different counterparty. Counterparty risk remains while terminating with different counterparty. Opposite contract on the exchange. Contract size Depending on the transaction and the requirements of the contracting parties. Standardized Market Primary & Secondary Primary Pricing of Futures contract (or Forward contract) A futures contract is a contract for delivery of a standard package of a standard commodity or financial instrument at a specific date and place in the future but at a price that is agreed when the contract is taken out. Certain futures contracts, such as on stocks or currency, settled in cash on the price differentials, because clearly, delivery of this particular commodity would be difficult. The futures price is determined as follows: Futures Price = Spot Price + Costs of Carrying The spot price is the current price of a commodity. The costs of carrying of a commodity reflects the cost of holding the underlying asset or shares over the life of the futures contract reduced b...
