Page 131 - DCOM507_STOCK_MARKET_OPERATIONS

Stock Market Operations

Notes a change in prices by that date. Such transaction would take place through a forward market.
Forward contracts are not traded on an exchange; they are said to trade over the counter (OTC).
The quantities of the underlying asset and terms of contract are fully negotiable.

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Caution The secondary market does not exist for the forward contracts and faces the
problems of liquidity and negotiability.

6.5.1 Problems in Forward Contracting

The forward contracts are affected by the problems like:
(a) Lack of centralisation of trading,
(b) Illiquidity, and

(c) Counter party risk.

6.6 Futures Contract

The futures contract is traded on a futures exchange as a standardised contract, subject to the
rules and regulations of the exchange. It is the standardisation of the futures contract that facilitates
the secondary market trading. The futures contract relates to a given quantity of the underlying
asset and only whole contracts can be traded and trading of fractional contracts is not allowed in
futures contracting.
The terms of the futures contracts are not negotiable. A futures contract is a financial security,
issued by an organised exchange to buy or sell a commodity, security or currency at a
predetermined future date at a price agreed upon today. The agreed upon price is called the
‘futures price’.

6.6.1 Types of Futures Contract

Futures contracts may be classified into two categories:
1. Commodity Futures: Where the underlying is a commodity or physical asset such as
wheat, cotton, butter, eggs etc. Such contracts began trading on Chicago Board of Trade
(CBOT) in 1860s. In India too, futures on soyabean, black pepper and spices have been
trading for long.
2. Financial Futures: Where the underlying is a financial asset such as foreign exchange,
interest rates, shares, Treasury bills or stock index.

6.6.2 Standardised Items in Futures

The standardised items in any futures contract are:
(a) Quantity of the underlying

(b) Quality of the underlying (not required in financial futures)
(c) The date and month of delivery
(d) The units of price quotation (not the price itself) and minimum change in price (tick-size)
(e) Location of settlement

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