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Future Contracts

History of Futures markets The futures market was the development following the forwards market. While the forwards markets took centuries to evolve, they provided good assurance against price uncertainties and later on, started becoming more standardized and regulated. Futures market, as they now exist in the US, are a fairly recent development, but understanding their origins help us to appreciate the role the markets play today and likely future changes in that role. The futures market were originally developed to meet the needs of the farmers and merchants. In the 19th century, commodity options were widespread in the US and till the first half of the 20th century were traded in London. Various scandals and abuses in prices coupled with non-delivery of the underlying assets resulted in the total ban of commodity options and the further formation of the Commodity Futures Trading Commission and the rising popularity of the futures contracts first in the US and then throughout the world.

Definition of Futures A futures contract can be defined as an agreement to buy or sell a standard quantity of a specific instrument at a predetermined future date and at a price agreed between the parties through open outcry on the floor of an organized futures exchange. Futures are considered to be better when compared to forwards because of the following reasons: i. ii. iii. iv. Standard volume Liquidity Counterparty guarantee by exchange Intermediate cash flows.

Types of Futures The different types of futures contracts traded, fundamentally fall into four different categories based on the underlying asset. The underlying asset may be: A foreign currency (say Euro, Yen or Swiss Franc, etc) An interest-earning asset(say a debenture or time deposit) An index (usually a stock index) A physical commodity (say, wheat, corn, etc.) Futures on individual stock.

i. ii. iii. iv. v.

The cost of carry model of determining futures prices The extent to which the futures price exceeds the cash price at one point of time is determined by the concept called cost of carry that refers to the carrying changes. The carrying charges can be further classified into storage, insurance, transportation and financing costs. The significance of carrying costs cannot be ignored because they play a crucial role in determining pricing relationships between the spot and futures prices. Moreover , it plays a key role in determining the prices of various futures contracts of maturities. The following formula determines the relationship between the cash price and the futures price of any commodity.

Flt = C + Ct *Slt* T-t/365+Glt Where, Ct = cash price at time t. Slt = Annualized interest rate on borrowings. Glt = Storage costs.

T-t= Time period. Flt= The futures price at time t, which is to be delivered at time period T.

Conclusion Investment in future contract is very risky due to expiry of this contracts , because investor can not invest his amount in future contract for long term. Here in the future there is specific time period of the contract.

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