Page 53 - DCOM510_FINANCIAL_DERIVATIVES

Financial Derivatives

Notes Metals and Petroleum, and
Financial Assets (individual stocks, indices, interest rate, currency).

4.1.2 Characteristics of Futures Contracts

Following are the salient features of futures contracts:
1. Futures are highly standardised contracts that provide for performance of contracts through
either deferred delivery of asset or final cash settlement;
2. These contracts trade on organised futures exchanges with a clearing association that acts
as a middleman between the contracting parties;
3. Contract seller is called ‘short’ and purchaser ‘long’. Both parties pay margin to the clearing
association. This is used as performance bond by contracting parties;

4. Margins paid are generally marked to market-price everyday;
5. Each futures contract has an associated month that represents the month of contract delivery
or final settlement. These contracts are identified with their delivery months like July-
Treasury bill, December $/DM etc.;
6. Every futures contract represents a specific quantity. It is not negotiated by the parties to
the contract. One can buy or sell a number of futures contracts to match one’s required
quantity. Because of this feature, 100% hedging is not possible. There may be over or
under-hedging to some extent.
4.1.3 Standardisation of Futures Contracts

Thus, futures contracts are highly standardised, to ensure that they are liquid. The standardisation
usually involves specifying:

The underlying this can 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 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 not only the quality of the
underlying goods but also the manner and location of delivery;

The delivery month;
The last trading date;

Other details such as commodity tick, the minimum permissible price fluctuation.
4.1.4 Categories of Futures Contracts

Futures contracts are of two major categories:
1. Financial Futures
2. Commodity Futures

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