This chapter describes the workings of futures markets and the mechanics of trading in these markets. We show how futures contracts are useful investment vehicles for both hedgers and speculators and how the futures price relates to the spot price of an asset. We also show how futures can be used in several risk-management applications. This chapter deals with general principles of future markets. Chapter 23 describes specific futures markets in greater detail. | Chapter 22 Futures Markets Forward - an agreement calling for a future delivery of an asset at an agreed-upon price Futures - similar to forward but feature formalized and standardized characteristics Key difference in futures Secondary trading - liquidity Marked to market Standardized contract units Clearinghouse warrants performance Futures and Forwards Futures price - agreed-upon price at maturity Long position - agree to purchase Short position - agree to sell Profits on positions at maturity Long = spot minus original futures price Short = original futures price minus spot Key Terms for Futures Contracts Profits: Futures Buyers and Call Buyers Profit Price 0 Call Buyer Futures Buyer Fo Profits: Futures Sellers and Put Buyers 0 Profits Price Futures Seller Put Buyer Fo Agricultural commodities Metals and minerals (including energy contracts) Foreign currencies Financial futures Interest rate futures Stock index futures Types of Contracts Clearinghouse - acts as a party to all . | Chapter 22 Futures Markets Forward - an agreement calling for a future delivery of an asset at an agreed-upon price Futures - similar to forward but feature formalized and standardized characteristics Key difference in futures Secondary trading - liquidity Marked to market Standardized contract units Clearinghouse warrants performance Futures and Forwards Futures price - agreed-upon price at maturity Long position - agree to purchase Short position - agree to sell Profits on positions at maturity Long = spot minus original futures price Short = original futures price minus spot Key Terms for Futures Contracts Profits: Futures Buyers and Call Buyers Profit Price 0 Call Buyer Futures Buyer Fo Profits: Futures Sellers and Put Buyers 0 Profits Price Futures Seller Put Buyer Fo Agricultural commodities Metals and minerals (including energy contracts) Foreign currencies Financial futures Interest rate futures Stock index futures Types of Contracts Clearinghouse - acts as a party to all buyers and sellers. Obligated to deliver or supply delivery Closing out positions Reversing the trade Take or make delivery Most trades are reversed and do not involve actual delivery Trading Mechanics Initial Margin - funds deposited to provide capital to absorb losses Marking to Market - each day the profits or losses from the new futures price are reflected in the account. Maintenance or variation margin - an established value below which a trader’s margin may not fall. Margin and Trading Arrangements Margin call - when the maintenance margin is reached, broker will ask for additional margin funds Convergence of Price - as maturity approaches the spot and futures price converge Delivery - Actual commodity of a certain grade with a delivery location or for some contracts cash settlement Margin and Trading Arrangements Speculation - short - believe price will fall long - believe price will rise Hedging - long hedge - protecting against a rise in price short hedge - protecting against a .
