Page 133 - DCOM507_STOCK_MARKET_OPERATIONS

Forward contracts Future contracts
1. The contract price is not publicly disclosed 1. The contract price is transparent.
and hence not transparent.

2. The contract is exposed to default risk by 2. The contract has effective safeguards
counterparty.
Stock Market Operations against defaults in the form of clearing
corporation guarantees for trades and
daily mark to market adjustments to the

accounts of trading members based on
daily price change.
Notes 3. Each contract is unique in terms of size, 3. The contracts are standardised in terms
expiration date and asset type/quality. of size, expiration date and all other
4. The contract is exposed to the problem of features.
liquidity. 4. There is no liquidity problem in the
5. Settlement of the contract is done by delivery contract.
of the asset on the expiration date. 5. Settlement of the contract is done on cash
basis.

6.6.6 Participants in Futures Market

The major players in the futures market are Hedgers, Speculators and Arbitrageurs.

 Hedgers: Hedgers wish to eliminate or reduce the price risk to which they are already
exposed. The hedging function solely focuses on the role of transferring the risk of price
changes to other holders in the futures markets.
 Speculators: Speculators are that class of investors who willingly take price risks to profit
from price changes in the underlying.
 Arbitrageurs: Arbitrageurs profit from price differential existing in two markets by
simultaneously operating in two different markets.

Self Assessment

Fill in the blanks:

11. ................................... wish to eliminate or reduce the price risk to which they are already
exposed.
12. ................................... are that class of investors who willingly take price risks to profit from
price changes in the underlying.

6.7 Trading Strategies in Futures Contracts

 Buy a future to agree to take delivery of a commodity. This will protect against a rise in
price in the spot market as it produces a gain if spot prices rise. Buying a future is said to
be going long.
 Sell a future to agree to make delivery of a commodity. This will protect against a fall in
price in the spot market as it produces a gain if spot prices fall. Selling a future is said to be
going short.

A futures contract is a contract for delivery of a standard package of a standard commodity or
financial instrument at a specific date and place in the future but at a price that is agreed when the
contract is taken out. Certain futures contracts, such as on stocks or currency, settled in cash on
the price differentials, because clearly, delivery of this particular commodity would be difficult.
The futures price is determined as follows:

Futures Price = Spot Price + Costs of Carrying
The spot price is the current price of a commodity. The costs of carrying of a commodity will be
the aggregate of the following:

(a) Storage
(b) Insurance
(c) Transport costs involved in delivery of commodity at an agreed place.

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