Futures

Futures

Future contracts are agreements between two parties to buy or sell an asset (underlying) at a given point of time in the future. They are standardized contract i.e. an agreement, traded on a futures exchange, to buy or sell a standardized quantity of a specified commodity of standardized quality at a certain date in the future, at a price (the futures price) determined by the parties involved. The future date is called the delivery date or final settlement date. The official price of the futures contract at the end of a day's trading session on the exchange is called the settlement price for that day of business on the exchange.

Assume that no cash settlement was done between the two parties. A futures contract gives the holder the obligation to make or take delivery under the terms of the contract. Also both parties of a futures contract must fulfill the contract on the settlement date – it is legally binding. The seller delivers the underlying asset to the buyer, or, if it is a cash-settled futures contract, then cash is transferred from the futures trader who sustained a loss to the one who made a profit. Money lost and gained by each party on a futures contract are equal and opposite. In other words, a future trading is a zero-sum game.

Future prices are not definitive statements of prices in the future. In fact they are not even necessarily predictions of the future. But they are important pieces of information about the current state of a market, and futures contracts are powerful tools for managing risks.

Terminology
Underlying: It is the asset or index on which a derivative is written. For example a futures index has the underlying as an index.

Delivery Date: This is the date at which the underlying will be delivered by the seller to the buyer. It is also known as final settlement date.

Future Price: This is the agreed upon or prearranged price determined by the instantaneous equilibrium between the forces of supply and demand among competing buy and sell orders on the exchange at the time of the purchase or sale of the contract. Simply, the price prearranged between the seller and the buyer.

Standardization: Futures contracts ensure their liquidity by being highly standardized, usually by specifying:

• The underlying asset or instrument. This could be anything from a barrel of crude oil to a short term interest rate.
• The type of settlement, either cash settlement or physical settlement.
• The amount and units of the underlying asset per contract. This can be the notional (fictional) amount of bonds, a fixed number of barrels of oil, units of foreign currency, the notional amount of the deposit over which the short term interest rate is traded, etc.
• The currency in which the futures contract is quoted.
• The grade of the deliverable. In the case of bonds, this specifies which bonds can be delivered. In the case of physical commodities, this specifies the quality of the underlying goods
• The delivery month
• The last trading date

Types of Futures Contracts

There are a large number of futures contracts trading on future exchanges around the world.

Agricultural Commodities: This category is the oldest group of futures contracts. It includes all widely used grains such as wheat, soybeans, corn and rice. Additionally, futures are traded actively on Cocoa, coffee, orange juice, sugar, cotton, wool, wood, and cattle.

Equities: Futures are actively traded on individual stocks as well as index. These are generally cash settled i.e. no exchange of stocks happens between the contracted parties; only the party which lose (prices of stocks move against them) gives money to the party which wins. Stock index futures have been quite popular in the market. These contracts are generally indices of a combination of stocks.

Natural Resources: Futures contracts are actively traded on metals and natural resources. Metals include gold, silver, copper, aluminum etc while natural resources include crude.

Foreign Currencies: There is a very large market of futures contract traded on foreign currencies because a large number of multinational companies are concerned about the volatility (changes) in the value of currencies of different countries where they sell or buy their products. Most popular currencies are Japanese Yen (¥), British Pound (£), Euro (€) and Swiss Franc (CHF).

Source: theindianmoney.com

bank bail-outs

I am getting increasingly angry at the UK government throwing taxpayers' cash down the drain to bail out failed banks. Lots of it. In spite of all the commentary I have read from numerous analysts, I remain totally unconvinced that it is the right thing to do. Some banks are failing because they made some very stupid deals. Others are not failing, because they didn't. Building societies that didn't get involved in buying bad debt are doing fine. The obvious solution is to let market economics run its course. Companies that make enormous mistakes go bust. So let them. It's a tough world out there, and no company should have a god-given right to success. Most companies only last a few years before they die, but although that is sad, it leads to better companies, a better deal for customers, and a more efficient economy. The banks are bigger, but the rules should still apply to them.

The government (and many others) believe we need to bail them out because the economy cannot work without them. Why? Why not just let the surviving banks pick up the customers as their failed competitors collapse? Surely building societies would naturally grow back to their positions before their cousins mistakenly decided to become banks and surviving banks could apply their proven better practices to the rest of the industry. People would be able to borrow and lend via surviving banks. Since survivors would presumably be able to pick up staff and computers and buildings, and even some of the better managers, surely it would all return to reasonable normal efficient working in no time? By offering bail-outs even as a distant possibility, the government has encouraged banks to forfeit responsibility for their own survival. The result has been disastrous, with many people kept in lucratively rewarded jobs who deserved fully to be unemployed or even prosecuted for negligence, while the enormous consequences of their actions are paid for by wholly innocent people who in most cases can ill-afford to help.

Much of the commentary is about the failure of capitalism. I think that is mis-stating the situation. It is a failure of part of the banking system to apply due care and diligence in a free market. Like any market, some of the produce on offer was good, some bad. Companies that failed to take the effort to inspect products before purchase deserve to suffer the consequences, up to and including their own demise it the mistakes are big enough.

As for the shareholders of the banks, the same law applies. Don't buy things you don't understand. It is no defense to argue that these companies appeared to be sound. Banks were involved in very tricky business. Investing in them without understanding the risks of that business was unwise. The rewards were attractive when times were good, but that came at the price of risk, and it is unreasonable to demand protection from that risk while reaping the rewards while all is well.

The only people for whom I think protection should exist are the ordinary people who deposited their money in the banks. It is right that the government should protect them, certainly up to the celing level, above which it could once again perhaps be argued that the owners should know better than to have all their eggs in one basket.

The market is a jungle. There are tigers and cute little bunnies. Animals quickly learn to distinguish them, or they get killed. But jungles work very well, and support a rich diversity of fauna and flora. Human markets are just the same, but the same care is needed, because similar rules apply. Banks should have known better. They didn't, so they should have been allowed to die, with the market ecosystem quickly adapting to their demise, followed by a rapid return to normal healthy operation. Interference by government has wrecked it.