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Chapter 16

CFIN501- Chapter 16- Future Contracts.docx

6 Pages
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Department
Finance
Course Code
FIN 501
Professor
Edward Blinder

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CFIN501 Chapter 16 Future ContractsFuture Contracts BasicsForward contractagreement between a buyer and a seller who both commit to a transaction at a future date at a price set by negotiation todayGenius of forward contractingallows a producer to sell a product to a willing buyer before it is actually producedSetting a price todayboth buyer and seller remove price uncertainty as a source of riskoLess riskbuyers and sellers mutually benefit and commerce is stimulatedFutures contractcontract between a seller and a buyer specifying a commodity or financial instrument to be delivered and paid at contract maturityoManaged through an organized futures exchangeFutures priceprice negotiated by buyer and seller at which the underlying commodity will be delivered and paid for to fulfill the obligations of a futures contractSponsorship through a futures exchangemajor distinction between futures contract and forward contractFutures contractsstandardized in terms of contract size delivery date and qualityListen on exchangescome with many standardized featuressize of the contract and the delivery dateoComes with tradeoffs relative to forward contractsStandardization of futures contracts facilitates the trading of contracts after they are created increasing liquidityFutures contracts are managed by the exchangeless counterparty riskoExchange ensures that both sides of the trade can cover any potential losses they might incuroAdvantages of futures contracts will outweigh the disadvantagesModern History of Futures tradingOldest organization futures exchange in the USChicago Board of TradeoEstablished in 1848grew with the westward expansion of American ranching and agricultureoLargest most active futures exchange in the worldAmerican futures exchangeoMidAmerica Commodity ExchangeoNew York cotton exchangeoNew York mercantile exchange oChicago Mercantile exchangeoNew york coffee exchangeoKansas City Board TradeCanadaWinnipeg commodity exchangeoIntercontinental Exchange acquired the Winnipeg Exchange ICE Futures CanadaMore than 100 yearsfutures exchange devoted their activity exclusively to commodity futureso1970sintroduced financial futuresCommodity futuresdelivery of physical commodityFinancial futures require delivery of financial instrumentsInterest rate futuresspecifies delivery of a fixed income securityStock index futuresspecifies particular stock market index as its underlying instrumentMontreal exchangeinterest rate futuresoThree month bankers acceptance futureso30 day repo futuresoTwo year government of Canada bank futuresoTen year government of Canada bonds futuresSuccessconstitute the bulk of all futures tradingoFinancial futures have become an indispensable tool for financial risk management by corporations and portfolio managerReduce risk through hedging strategies or to increase risk through speculative strategiesFutures contract FeaturesDerivative securityvalue of the contract is derived from the value of the underlying instrumentExchange traded futures contracts are standardized to facilitate convenience in trading and price reporting1
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